Annual Earnings Growth

One of the most significant indicators to consider when investing in stocks or companies is annual earnings growth. This metric clearly shows a company’s profitability and ability to generate consistent income over time. While it might seem straightforward, understanding annual earnings growth requires understanding how it works, why it matters, and how to interpret it correctly. 

What is Annual Earnings Growth? 

Annual earnings growth refers to the percentage increase in a company’s net income over one year. Net income, often referred to as profit, is the amount of money a company retains after subtracting all expenses, taxes, and operating costs from its revenue. 

This metric is typically used by investors and analysts to assess a company’s financial performance. It gives insights into whether a company is growing its profits, stagnating, or declining. A positive earnings growth rate indicates profitability, while a negative rate suggests losses or declining financial health. 

The formula for Annual Earnings Growth 

The basic formula for calculating annual earnings growth is: 

Annual Earnings Growth Rate = Current Year Earnings – Previous Year Earnings/Previous Year Earnings*100 

Example Calculation 

Imagine a company reports the following earnings over two years: 

• Earnings in Year 1: US$5,000,000 

• Earnings in Year 2: US$6,500,000 

The annual earnings growth rate can be calculated as: 

Growth Rate = 6,500,000 – 5,000,000/5,000,000*100 = 30% 

This means the company’s earnings grew by 30% from Year 1 to Year 2. 

Importance of Tracking Annual Earnings Growth for Investors 

For investors, tracking annual earnings growth is critical in assessing a company’s financial health and potential for future profitability. It provides valuable insights into how a company performs over time, helping investors make informed decisions. Below are the key reasons why understanding this metric is so important: 

1. Indicator of Profitability

Annual earnings growth directly reflects how efficiently a company manages its operations and expenses to generate profits unlike revenue growth, which only considers total sales, earnings growth accounts for all costs, including production, marketing, and administrative expenses.  

Consistent earnings growth shows that a company can sustain its profitability despite market fluctuations, rising costs, or competitive pressures. This is especially important for investors seeking companies with solid financial foundations. 

2. Drives Stock Price Growth

Earnings growth is one of the primary factors influencing stock prices. Investors are generally willing to pay a premium for shares of companies that demonstrate consistent and strong earnings growth because it suggests the company has robust profitability and potential for higher returns.  

Higher earnings growth rates also lead to higher valuations, often measured by metrics like the Price-to-Earnings (P/E) ratio. This can result in capital appreciation for investors, making it a key metric for long-term investment strategies. 

3. Helps Evaluate Long-Term Performance

Annual earnings growth eliminates the noise caused by short-term factors impacting quarterly results, such as seasonal trends or temporary disruptions.  

Focusing on year-over-year growth allows investors to gain a clearer perspective on a company’s trajectory and assess whether it can maintain consistent performance over time. This is especially useful for evaluating a company’s resilience and sustainability. 

4. Supports Decision-Making

Annual earnings growth is a powerful comparative tool. When investors analyse companies within the same industry, those with higher and more stable earnings growth are often viewed as better investments. This metric helps investors identify market leaders and avoid companies with declining or inconsistent financial performance, guiding them toward more reliable investment opportunities. 

Differences Between Earnings Growth and Revenue Growth 

It’s common for new investors to confuse earnings growth with revenue growth. While both metrics are important, they measure different aspects of a company’s performance. 

Example to Illustrate the Difference 

• A company generates US$10 million in revenue in Year 1, which grows to US$12 million in Year 2. This represents a revenue growth of 20%. 

• However, if the company’s expenses increase significantly, reducing its net income from US$2 million to US$1.8 million, its earnings growth would be negative (-10%). 

This highlights why earnings growth is often considered a more reliable measure of profitability than revenue growth. 

Methods to Calculate Annual Earnings Growth Rate 

There are multiple ways to calculate and interpret annual earnings growth. Below are the most common methods: 

1. Year-Over-Year (YoY) Growth

This is the simplest and most commonly used method. The formula has already been discussed, and net earnings from one year are compared to the next. 

2. Compound Annual Growth Rate (CAGR)

The CAGR method measures a company’s earnings’ average annual growth rate over a longer period. It is beneficial for assessing performance over three, five, or ten years. 

The formula for CAGR is: 

CAGR = (Ending Value / Beginning Value)^(1/n) – 1 

Where: 

• Ending Value is the earnings in the final year 

• Beginning Value is the earnings in the initial year 

• n is the number of years 

For example: 

• Earnings in Year 1: US$1,000,000 

• Earnings in Year 5: US$2,000,000 

• n: 5 years 

CAGR: 

CAGR = (Ending Value / Beginning Value)^(1 / Number of Years) – 1 

This shows the company’s earnings grew by an average of 14.87% per year over five years. 

3. Earnings Per Share (EPS) Growth Rate

EPS measures the portion of a company’s earnings allocated to each share of stock. The EPS growth rate is often used to assess profitability per share. 

Examples of Annual Earnings Growth 

Example 1: Amazon (US Market) 

Amazon has been a shining example of sustained annual earnings growth, driven by its leadership in e-commerce and cloud computing services through Amazon Web Services (AWS). Even during volatile periods such as the COVID-19 pandemic, the company showcased its ability to adapt and thrive, resulting in impressive growth. 

Financial Data: 

• Earnings in 2020: US$21.33 billion 

• Earnings in 2021: US$33.36 billion 

The annual earnings growth rate can be calculated as: 

Growth Rate = [(New Value – Old Value) / Old Value] * 100 

This substantial increase in earnings was primarily due to a surge in demand for online shopping during global lockdowns and the significant expansion of AWS. As consumers shifted to online purchasing and businesses moved their operations to the cloud, Amazon leveraged its market dominance to achieve remarkable growth. The company’s ability to innovate, expand its services, and manage costs effectively contributed to this success, solidifying its position as a global leader. 

Example 2: Singapore Exchange (SGX Market) 

The Singapore Exchange (SGX) is another example of steady annual earnings growth, driven by increased trading volumes, particularly in derivatives, and a growing demand for investment products. SGX has demonstrated resilience and adaptability in meeting investor needs, even amidst changing global financial conditions. 

Financial Data: 

• Earnings in 2022: SGX 500 million 

• Earnings in 2023: SGX 575 million 

The annual earnings growth rate is: 

Growth Rate = [(New Value – Old Value) / Old Value] * 100  

This growth reflects SGX’s strategic initiatives to diversify its product offerings and cater to an expanding global investor base. The company’s focus on derivatives trading and risk management products was pivotal in enhancing its revenue and profitability. 

Frequently Asked Questions