Course 203: Different Types of Growth Rates
Earnings Growth
In this course
1 Introduction
2 Sales Growth
3 Earnings Growth

Once a company is profitable, earnings growth becomes a key number. Generating profits is one of the most important functions of a company, and ideally a firm's earnings will grow at a healthy pace along with its revenues. Microsoft MSFT is a good example. From 1996 through 1999, its revenues grew about 30% annually, and its earnings grew about 50% annually. On the other hand, when companies' earnings growth slows unexpectedly, their stock prices usually plummet. That's what happened to funeral-home operator Service Corporation International SRV in early 1999. After years of steady earnings growth, Service Corp. lost half of its market value after it announced its earnings would come in far below what analysts expected. As with any number, earnings growth can be misleading. Sometimes a company's seemingly impressive earnings growth is the result of acquisitions. For example, between 1995 and 1998, USA Interactive's USAI earnings grew an astonishing 786% annually. The company had gone on an acquisition spree during that time, increasing its revenue 50-fold. Much of that growth came from adding completely new businesses (most notably, the USA Network and Sci-Fi Channel cable channels) to the company's income statement, not from organic growth in the existing businesses. It is also possible for a single year of depressed earnings to distort growth rates. For example, Kimberly-Clark KMB, maker of Kleenex and many other products, grew its earnings a seemingly impressive 227% annually between 1995 and 1998. But the company's reported 1995 earnings were depressed because of a $1.4 billion merger-related charge, so that three-year growth rate is misleading. Kimberly-Clark's operating earnings (not including special charges) only grew 2.5% annually during the same period, painting a very different picture. It is easy to put growth on a pedestal, especially in a market that seems to value rapid growth above everything else (including profitability). But although growth rates are certainly an important part of evaluating any stock, they're only one part. Putting them in the appropriate context can help you distinguish between the next Microsoft and a company that is growing its way to oblivion.

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