What is Earnings Power?
Earnings power is the ability to generate profits.
How Does Earnings Power Work?
Company XYZ is a start-up that sells pet rocks. At first, the company sells 40,000 units after a celebrity is photographed taking hers to a movie set. The company makes $500,000 of profit. Over the next year, the company sells an additional 50,000 units, but because the celebrity enters rehab and people eventually figure out that they can make their own pet rocks, the company only sells 1,000 units per year for the next two years.
Because the company was so dependent on celebrity approval and only offered a 'fad' product, Company XYZ does not have earnings power. That is, the company's business model is unlikely to generate steady, consistent profits over time.
Earnings per share (EPS) is not the only way to measure earnings power. Return on assets (ROA) and return on equity (ROE) are also popular measures.
Why Does Earnings Power Matter?
When analysts look at earnings power, they typically look for long-term earnings power -- that is, the ability to survive for a long time.
