An income statement shows a company's financial performance over a period of time. It helps investors understand how much revenue the business generated, what it spent to operate, and how much profit remained.
Looking at one income statement can be useful, but examining several years can provide much more information. Trends in revenue, expenses, margins, and earnings can help reveal whether a company's financial performance has been improving, weakening, or remaining relatively consistent.
1. Revenue
Revenue, sometimes called sales, is the money a company generates from its normal business activities before expenses are deducted.
Revenue growth can be encouraging, but increasing revenue by itself does not necessarily mean the business is becoming more profitable. Expenses may be growing just as quickly—or even faster.
Investors should therefore examine revenue together with profitability rather than treating sales growth alone as evidence of financial strength.
2. Cost of Revenue and Gross Profit
Many businesses incur direct costs to produce the goods or services they sell. These costs are commonly reported as cost of revenue or cost of goods sold.
Gross profit is generally calculated as:
Revenue − Cost of Revenue = Gross Profit
Gross profit helps show how much remains after the direct costs associated with generating revenue.
3. Operating Expenses
Companies also have expenses associated with running the business. Depending on the company, these may include selling and marketing expenses, research and development, administrative costs, salaries, and other operating expenses.
These expenses matter because a company can produce substantial gross profit but still have weak overall profitability if operating expenses consume most of it.
4. Operating Income
Operating income measures profit generated from the company's operations after operating expenses have been deducted.
It can help investors evaluate the profitability of the underlying business before considering certain non-operating items such as interest and taxes.
Examining operating income over several years can help reveal whether improvements in revenue are translating into improvements in operating profitability.
5. Net Income
Net income is the company's profit after expenses, interest, taxes, and other applicable items have been accounted for.
Net income is often referred to as the company's “bottom line” because it appears near the bottom of the income statement.
Positive net income means the company reported a profit for the period, while negative net income represents a loss.
As with other financial measures, investors should examine the trend over several years rather than relying on a single period.
6. Earnings Per Share (EPS)
Earnings per share, or EPS, relates a company's earnings to its outstanding common shares.
A simplified representation is:
EPS = Earnings Available to Common Shareholders ÷ Weighted-Average Common Shares Outstanding
EPS can help investors examine the amount of earnings attributable to each share, but changes in the number of shares outstanding can affect EPS.
For example, share repurchases may reduce the number of shares outstanding, which can increase EPS even when total company earnings have not increased by the same percentage.
7. Profit Margins
Profit margins place profits in relation to revenue. Instead of looking only at how many dollars a company earns, margins can help show how efficiently revenue is being converted into profit.
Common measures include gross margin, operating margin, and net profit margin.
For example:
Net Profit Margin = Net Income ÷ Revenue × 100
A company earning $10 million on $100 million of revenue would have a 10% net profit margin.
Margin trends can be particularly useful when comparing a company with its own historical performance. Industry differences should also be considered because normal margins vary substantially among different types of businesses.
8. Why Several Years Matter
A single strong year does not necessarily establish a strong long-term business, and one difficult year does not necessarily establish a weak one.
Reviewing several years of revenue, operating income, net income, EPS, and margins can help investors distinguish longer-term trends from temporary changes.
This is one reason Stock Sage examines a company's historical financial performance rather than relying solely on the latest year.
9. Warning Signs Worth Researching
An income statement can identify areas that deserve additional investigation. Examples include declining revenue, repeated losses, shrinking profit margins, rapidly increasing expenses, or earnings that fluctuate substantially from year to year.
These observations are not automatically reasons to reject a company. They are signals that may warrant further research into what caused the changes.
How Stock Sage Uses Earnings History
Stock Sage uses historical profitability as one part of its fundamental qualification process.
One of Stock Sage's fundamental requirements is that a company have positive EPS in at least 4 of the previous 5 years.
This requirement is designed to identify companies with a demonstrated history of profitability while allowing for an occasional difficult year.
EPS alone does not establish that a company is fundamentally sound. Stock Sage considers it together with balance-sheet information and other financial measures before a company qualifies for further research.