Why Net Income Might Be the Least Important Line Item on an Earnings Report

A company’s profits usually take center stage when an earnings report is released, however, that can be very misleading. When investors see that a company doubled its profit or saw a big increase in net income, the immediate perception is that the company had a good result.

The problem is that net income can be influenced by many factors, such as gains on sales and foreign exchange; items that are independent of the company’s day-to-day operations. The current quarter can also look like a big improvement simply by not having losses or unfavourable items that were incurred in the prior year.

Profits are important, but investors shouldn’t look just at net income to assess year-over-year performance.

Instead, it might be more useful to look at a company’s operating income or EBITDA number. Some companies release adjusted net income or adjusted EBITDA amounts that take out irregular and non-recurring items so that you are able to have a fair comparison from one period to the other.

The problem is that if you go to a financial website that shows a company’s recent performance this type of information will not be included since what a company tracks may be different from one company to the next.

These problems reinforce the importance of actually looking at a company’s financials to assess whether or not the company has done well based on a variety of different factors and metrics. Looking just at the bottom line, or just the headline, can give you an inaccurate picture of how the company performed.