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Trying to figure out how much a company is worth is one of the most elusive endeavors in finance. Sometimes, the companies themselves don’t have a full idea.
However, companies provide earnings reports every quarter as required by the SEC.
Understanding the difference between earnings and revenue is an important part of finding out the worth of a company and, by extension, how to price the stock.
What is Revenue?
“Revenue” is the total gross income that a company pulls in from sales. This is the total amount of money made in a given time period without any deductions or adjustments.
Amazon, for example, posted revenue for their 2021 first quarter of $108.52 billion. Sure, this is a lot of money, especially when you consider that’s just over a span of three months.
However, revenue alone does not paint a complete picture of a company’s success. We’ll get more into that later.
There are at least two types of revenue, and it depends on whether the company has different income streams in its business model.
- Operating Revenue: This is income from the sale of your company’s core products or services, and this would include rents from real estate income.
- Non-operating Revenue: Individuals make passive income, and businesses are no different. They are required to report income from interest as non-operating revenues. Also, the sale of any assets the company owns, regardless of profits, counts as non-operating income.
There are several other types of revenue that a company accountant or a Wall Street analyst would consider as well – sales, rents, dividends, interest, etc. – however, they can all usually fall within one of the two primary groups above.
What Are Earnings?
“Earnings” is another word used to describe net profits for a company, which is a company’s revenues less any and all business expenses.
Earnings are typically announced as a price per share. Continuing with the previous example, Amazon’s earnings were $15.79 per share for quarter 1 of 2021.
When you consider that Amazon has 504 million shares outstanding, this equates to about $7.9 billion in net profits ($15.79 earnings per share * 504 million shares).
A company’s earnings show how much profit that company can generate in a given period.
It is calculated by taking the revenues and deducting taxes, wages and other benefits paid to employees, depreciation of assets, rents and other utilities paid, and anything the company has to pay to generate revenues.
What Is the Difference Between Earnings and Revenue?
Revenues and earnings are similar, so they can sometimes be confused. Just to clear up the issue, the revenues are always gross profits without any deductions at all.
Earnings are the profits generated by the company calculated by starting with revenues then deducting all costs of doing business.
When a company reports earnings, they are usually reported together. For this reason, both together represent an extremely important barometer of a company’s performance.
They also provide some context to investors and shareholders that would not be clear if one were missing when reported together.
This point further illustrates the differences because they show different perspectives of a company’s financial health.
Most analysts look at hundreds of data points when evaluating a company’s performance.
However, these two especially provide the top-level summary of where they should start looking for indicators about future performance.
If revenues and profits both continue to rise in tandem, this would generally be seen as stable growth for that company.
On the other hand, if the revenues are rising but earnings are stagnant, this could point to too much money being spent on overhead.
Analysts may need to consider looking closer at company expenditures to determine where capital is being overspent and what might be the cause.
Earnings vs. Revenue Example
Let’s consider an example of how earnings and revenue can be tweaked to portray different pictures of company performance. Let’s use everyone’s favorite example stock, XYZ.
If XYZ were to report $10 billion revenue for the first quarter, that sounds like a ton of money in any terms.
Let’s further add that this represents a 5% year-over-year increase compared with 202 revenues.
As an extreme, if the company were to also report $0 earnings per share (EPS), this would essentially show the company is spending $10 billion in overhead.
Clearly, there are inefficiencies in how XYZ is conducting business to generate $10 billion in revenues.
This example was just used to show how revenues and earnings can be used to quickly analyze a company.
For a more realistic example, XYZ reported revenues of $10 billion and EPS of $2.50 with 500 million shares outstanding.
This shows revenues of $10 billion and profits of $1.25 billion ($2.50 * 500 million shares) – not bad!
However, to further illustrate how these numbers paint a picture, consider that XYZ’s $10 billion revenue represents the same 5% growth year over year as mentioned earlier.
However, the company made $1.5 billion in profits during the same quarter last year despite posting the $1.25 billion mentioned previously.
This represents a 16% drop in profits despite increased revenues!
Clearly, the company is spending too much somewhere. As an investor, you can now understand better where to look to figure out how efficiently a company is operating.
Bottom Line: Earnings vs. Revenue
To reiterate one of the most important points in this article, revenue numbers show a company’s total income without any deductions considered.
Earnings represent the net profits by starting with revenues and deducting all the company’s costs to make those revenues.
Both numbers are extremely important to analysts on Wall Street and regular investors alike.
They are generally reported together and provide two pieces of information that show how well a company is performing each quarter.
Not only are they important for investors, but the companies themselves use them to pinpoint inefficiencies in their own businesses.
When you combine these two numbers with historical trends, you can get a very good idea of the direction a company is going and decide whether they represent a stable investment over the long term.