Earnings Growth: Bottom Line Improvement
Revenue is vanity, profit is sanity. Earnings growth is what ultimately drives stock prices.
Why Earnings Growth Matters Most
Stocks are valued on earnings. The P/E ratio directly connects price to earnings.
If earnings grow 15% per year:
- Year 1: $4 EPS
- Year 5: $8 EPS (doubled!)
- Year 10: $16 EPS (4x!)
Even if the P/E stays constant, the stock price follows earnings higher.
Your Salary
Imagine your salary:
- Year 1: $50,000
- 10% annual raises
- Year 10: $130,000
Your "value" to employers grew because your earnings (salary) grew. Stocks work the same way—growing earnings = growing value.
Earnings Growth vs. Revenue Growth
| Scenario | What's Happening | Implication |
|---|---|---|
| Earnings > Revenue growth | Margins expanding | Very bullish |
| Earnings = Revenue growth | Margins stable | Healthy |
| Earnings < Revenue growth | Margins contracting | Concerning |
| Earnings negative, Revenue positive | Losing money to grow | Risky |
The best companies grow earnings faster than revenue through operating leverage.
Sources of Earnings Growth
1. Revenue Growth
More sales → more profit (if margins hold)
2. Margin Expansion
Same sales, higher profit percentage
3. Share Buybacks
Fewer shares → higher EPS (even with flat net income)
4. Lower Taxes
Tax cuts boost after-tax earnings
5. Lower Interest
Refinancing debt at lower rates
Key Takeaways
- Earnings growth directly drives stock price growth
- Earnings growing faster than revenue = expanding margins
- Quality earnings growth comes from operations, not financial engineering
- Consistency of earnings growth matters as much as the rate
Quality of Earnings Growth
Not all earnings growth is equal:
High-Quality Growth ✅
- From revenue growth and margin improvement
- Sustainable and repeatable
- Driven by competitive advantages
Lower-Quality Growth
- From cost-cutting alone (limited runway)
- From share buybacks (financial engineering)
- From one-time items (not repeatable)
- From accounting changes (not real)
Checking Earnings Quality
Compare earnings growth to:
- Revenue growth (should be similar or higher)
- Cash flow growth (should track earnings)
- Operating income growth (before financial items)
If earnings grow but cash flow doesn't, be skeptical.
Earnings Growth Expectations
What Analysts Expect
Wall Street analysts publish earnings estimates:
- Beat: Actual > Expected → Stock often rises
- Meet: Actual ≈ Expected → Stock flat
- Miss: Actual < Expected → Stock often falls
Forward Growth Rates
Analysts also estimate future growth:
- High growth: 15%+ expected
- Moderate growth: 8-15% expected
- Low growth: 0-8% expected
- Decline: Negative growth expected
The PEG Ratio Revisited
PEG = P/E ÷ Earnings Growth Rate
| PEG | Interpretation |
|---|---|
| < 1.0 | Potentially undervalued for growth |
| 1.0 | Fairly valued for growth |
| 1.0 - 2.0 | Might be expensive |
| > 2.0 | Likely expensive for growth |
Example:
- Stock A: P/E 30, Growth 30% → PEG 1.0 (fair)
- Stock B: P/E 30, Growth 15% → PEG 2.0 (expensive)
Same P/E, very different value proposition.
Earnings Growth Red Flags
🚩 Earnings growing, revenue flat — Where's growth coming from?
🚩 Earnings growing, cash flow declining — Accounting tricks?
🚩 One-time gains — Not sustainable
🚩 Acquisition-driven — Buying earnings, not earning them
🚩 Guidance cuts — Management expects slowdown
Earnings Growth Traps
- Assuming past growth continues forever
- Ignoring the source of earnings growth
- Not checking if cash flow confirms earnings
- Paying too much for expected growth
How ShareValue.ai Uses Earnings Growth
Our Growth Score incorporates:
- Historical earnings growth rate
- Revenue growth rate
- Growth consistency
- Comparison to sector peers
- Forward growth estimates
Next up: Financial health—the stability that lets growth continue.