Why do a company's earnings matter so much? Because earning growth is proof that a company's business strategy is working and that it is able to share its success among shareholders.
Companies announce earnings every quarter, each being a report card on the company's operations.
For investors, earnings matter because outstanding earnings growth is the single most common trait among the most successful stocks, research shows.
The IBD EPS Rating measures a company's earnings over the past three to five years plus the two most recent quarters. It compares those numbers to all other companies in the IBD database. That's a tremendous amount of profit analysis packed into a single number.
The rating goes on a scale of 1 to 99, with 99 being best. Investors should look for stocks with an EPS Rating of 80 or above.
Earnings Growth Analysis
A strong EPS Rating can sometimes reflect accelerating earnings growth, which is a bonus that great companies offer their investors.
In the security software industry group, Qualys had accelerating earnings growth last year. EPS climbed 9%, 20%, 22%, 43% and 61% from Q3 of 2022 to Q3 of 2023.
That helped the stock to a near-perfect EPS Rating of 98 in October 2023.
Earnings show that a company is profitable and in a position to share profits with shareholders. That attracts fund managers and brings institutional support to a stock. The number of funds holding Qualys went up from 705 in December 2022 to 736 in September 2023.
Strong EPS Rating Is Just One Factor
That does not mean that all stocks with positive earnings do well. Nor that only stocks with positive earnings outperform others.
Weatherford, a stock in the small-cap Russell 2000 index, saw losses in 2020 and 2021 and turned profitable in 2022. Yet, the oil and gas equipment maker boasts a gain of more than 700% from when it went public in June 2021 through October 2023. But Weatherford is not a typical example.
A company that continues to lose money is bound to go out of business at one point, taking investors' capital with it. An example of that is the 2000 internet bubble. Companies such as Pets.com closed doors soon after going public and after continuous losses.
By contrast, companies with consistent earnings growth are not likely to crumble easily.
Investors should use chart analysis and other tools to pick stocks. But the EPS Rating is a vital tool.
The rating can be found in IBD MarketSmith, the stock quotes at Investors.com, IBD Stock Checkup and the IBD Smart NYSE and Nasdaq Tables.
This article was originally published Oct.13, 2023, and has been updated. Please follow VRamakrishnan on X/Twitter for more news on the stock market today.
