Earnings Quality

  

It’s just math, right?

Whatever.com just produced $1.32 in earnings…one hundred thirty two cents of Wall Street lovin’ profit. How can there be a, uh...quality to that number? A number’s a number, right?

Well. Yes. But, rather, there are different qualities of earnings. What if we told you that 100 percent of whatever.com’s earnings came from ads it sold to 40,000 different buyers, because its website was just that popular? All of the growth came intrinsically, meaning that users just loved using it and nothing meaningful changed on their balance sheet other than that the cash account went up.

Okay. Very high quality earnings.

Really? Sure ‘bout that?

Hm…well what if we told you that 70% of their ad sales came from a subsidiary in China…and were all collected in RMB (the Chinese currency)? And that, in this quarter, the Chinese currency appreciated 38 percent. Essentially, all of their big growth came because the Chinese currency did well...not because their business did well.

So…wait. Had the Chinese currency just been flat, the company wouldn’t have earned anything close to $1.32…70 percent of the sales and almost 40 percent currency gain? It means that the company happened to have a lot of sales in a country with a fast appreciating currency; it wasn't necessarily a direct reflection that the company had high quality earnings .

Yes, it's great that they were in a hot market in a highly appreciating currency. But if the currency hadn’t gone up so much relative to the US dollar in which they report their earnings, the real earnings then would have been more like a dollar. Maybe less. So that’d be low quality earnings.

What about high quality earnings? Well, really simply...you said you’d sell 300 tractors this quarter. The Street thought you’d sell 310. You actually sold 320. You said margins would be 20 percent. The Street thought they’d be 22 percent. They actually were 25 percent. You said you’d generate $20 million in cash. The Street thought you’d generate 22. And you actually did generate 25.

Simple. You just did your core business…selling tractors…well. Quality earnings. Quality tractors.

Related or Semi-related Video

Finance: What is Earnings Quality?50 Views

00:00

Finance allah shmoop What is earnings quality Well it's just

00:07

math right Whatever Dot com just produced a dollar thirty

00:10

two in earnings One hundred thirty two cents of wall

00:13

street Love and profit How can there be a quality

00:16

to that number The number is a number right Well

00:19

yes but rather there are different qualities of earnings What

00:23

if we told you that one hundred percent of whatever

00:25

dot coms earnings came from Adsit sold tto forty thousand

00:29

different buyers because its website was just that popular All

00:33

of the growth came intrinsically meaning that users just loved

00:37

using the site and nothing meaningful changed on their balance

00:40

sheet or wall street Fancy engineers doing creative clever things

00:44

with the selling of money Other than that the cash

00:47

account went up because dead profits and they kept him

00:50

okay Those air very high quality earnings Really sure about

00:54

that C we threw a curveball in there We do

00:57

that all the time All right Well what if we

00:58

told you that seventy percent of their ad sales came

01:01

from a subsidiary in china and were all collected in

01:05

our m b the chinese currency and that in this

01:08

quarter well that the chinese currency appreciated thirty eight percent

01:12

relative to the dollar Well essentially all of their big

01:16

growth The big growth that we thought was such high

01:18

quality earnings came because the chinese currency did well not

01:22

because their business did all that well so wait Had

01:26

the chinese currency just been flat the company wouldn't have

01:29

earned anything close to a dollar thirty to seventy percent

01:33

of the sales and almost forty percent of currency gain

01:37

there Well it means that the company happened to have

01:40

a lot of sails in a country with a fast

01:42

appreciating currency It wasn't necessarily a direct reflection that the

01:46

company was doing so well and had such high quality

01:49

earnings Yeah it's great that they were in a hot

01:51

market and highly appreciating currency but if the currency hadn't

01:54

gone up so much relative to the u s dollar

01:56

in which they report their earnings toe wall street while

01:59

the real urn things end of the company would have

02:01

been more like a dollar maybe less so that it

02:04

be low quality earnings What about high quality earnings Well

02:09

really simply you said you'd sell three hundred tractors this

02:13

quarter the street thought you'd sell three hundred ten You

02:16

actually sold three hundred twenty you said margins would be

02:19

twenty percent The street thought they'd be twenty two percent

02:22

and they actually were twenty five percent You said you

02:25

generate twenty million dollars in cash the street thought you

02:28

generate twenty two and you actually did generate twenty five

02:32

million dollars in cash High quality financial results Simple You

02:36

just did your core business Selling tractors well Quality earnings 00:02:41.233 --> [endTime] quality tractors

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