What Is Earning Power?

Earning power represents a business' ability to generate profits over the long haul, ass🍒uming all current operational conditions generally remain constant.

Investors include a company’s earning power in their assessment of whether to buy the company's shares. Analysts also review it to determine if a company’s stock is worth investing in.

Understanding Earning Power

Earning power takes into account several elements, including a company’s ꦜtotal assets, plus recent growth orജ loss trends.

In determining earning power, companies and investors can consider metrics such as earnings before interest and taxes (EBIT), a company's return on assets (ROA), or the return on equity (ROE). All are measurements of financial performance.

Furthermore, some companies include the dividend yields associated𝓀 with specific securities in their assessment of earning power.

Earning Power Metrics

EBIT

A company can gain insight into its earning power by examining its earnings bef♔ore amounts for interest and tax are deducted.

EBIT is calculated as net income plus interest e🐽xpense plus tax expense. (The net income figure excludes interest expense and tax expense, s🦩o they need to be added back to come up with EBIT.)

EBIT represents a company’s profit based on continuous operations,𓂃 as well as cash flow. It includes operating and non-operating income and provides a reliable snapshot of a company’s liquidity profile, its ability to meet debt obligations, and its overall financial health.

Dividend Yield

Some individual sectors and/or industries place greater importance on certain earning power🔜 metrics than on others.

Case in point: Dividend yield carries more weight with well-established blue-chip companies than it does with rapidly growing startups. That's because startups are more apt to reinvest profits back into their operations during development stages.

澳洲幸运5官方开奖结果体彩网:Dividend yield is obtained by taking the annual dividends per share of stock and dividing that figure by the priജce per share.

Return on Assets

Return on assets (ROA) shows a company's profit relative to its asset💝s. ROA is ne👍t income divided by total assets.

The resulting figure te🧸lls us how well a company generates income from the assets in which it has invested. The higher the ROA percentage, the more efficient the company is at making money from it assets.

Return on Equity

Return on equity (ROE) is another measure of a company's ability to generate income. In this case, the metric compares net income to shareholder equity. ROE is net in🌞come divided by s🌊hareholder equity.

The higher the ROE figure, the more effe🅷ctive a company is at obtaining income and profit from the investment that shareholders have made in it.

Limits of Earning Power Metrics

The concept of earning power assumes that ideal business con🌌ditions will continue for a company. It does not account for any internal or exterꩲnal fluctuations that may negatively affect rates of production.

The𒁏refore, there is an ever-present risk that general market volatility, regulatory restrictions, or other unforeseen events may affect business flows in ways that earning power cannot an🐈ticipate.

The Basic Earning Power Ratio

The Basic Earning Power (BEP) formula is also referred to as 𓆏a ratio.

Basic Earning Power = Earnings before interest and taxes (EBIT) / Total assets

Let's say the Acme Company's income statement shows a net income of $15,000, taxes of $3,000 and interest expense of $250. Therefore, the figure for EBIT is $18,250.*

Acme's balance sheet shows a figure of $125,000 for total assets.

Thus, BEP is 14.6% ($18,250 / $125,000)

A high BEP means that a company is able to get more value from its assets. To determine if a BEP is high or low, you must compare it to a company's previous results. You can also compare a company's BEP to its peers' BEPs or to its industry BEP. All things being equal, higher BEPs are preferred.

*Recall that EBIT measures earnings before amounts paid for interest and taxes are deducted. The net income figure is net of all expenses, so interest and taxes must be added back to obtain EBIT for the calculation above.

Advantage and Disadvantage of BEP

Advantage

The advantage of using the Basic Earning Power ratio over other metrics is that its calculation uses EBIT. For one thing, that means it includes all income earned and not just operating income.ꦕ

In addition, it make☂s the comparisons of how well companies generate income from their assets more useful because it igno♌res the various tax situations and different degrees of borrowing that may exist from one business to another.

Disadvantage

BEP provides a single view of profitability and should be used in conjunction with other metrics for a comprehensive picture of performance. That's something all investors should be aware of.

The Bottom Line

Earning power provides a view of a company's financial health. It reflects a company's ability to earn money and make a profit. It's watched by investors and analysts as part of their investment decision-making and recommendation processes.

Various metrics can measure earning power. However, the Basic Earning Power🃏 ratio (BEP) is often used due to its treatment of income and the accuracy it provides in company-to-company comparisons.