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Cramer: Don’t Let EPS Mislead You

Monday, 22 Apr 2013 | 6:00 PM ET
Cramer: Earnings Can Be Deceiving
Monday, 22 Apr 2013 | 6:00 PM ET
Jim Cramer explains how headline numbers that get all the attention during earnings season can sometimes mislead new investors.

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Whenever a company reports earnings, the metric that usually gets all the attention is EPS or earnings per share. And that's not surprising, EPS is used to generate all kinds of other calculations.

However, if you're a new investor Cramer says to weigh EPS very carefully; it's not always as it appears.

That's because EPS can be driven by many factors. Although strong revenue is one of them it can also be driven by lower costs or even recent lay-offs.

Therefore a 'good' EPS isn't necessarily a sign that business is good.

Of course, it hardly signals trouble.

Cramer said the way in which to either confirm or deny the implications of the EPS, is to dig down and also identify revenue or the amount of money brought into a company by its business activities.

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Why is that?

Revenue reveals important details about growth – a company with strong revenues is likely growing. Conversely, a company that's cutting jobs may show a strong EPS number, but not strong revenue.

Here's another way to think about it.

Steve Cole | Vetta | Getty Images

"A company can't drive the sales line except by increasing demand, producing more, or gaining more customers" Cramer said. "However, a company can easily drive the earnings via buying back a ton of stock, cutting jobs, etc." Cramer explained.

Therefore revenue and specifically revenue growth drives Cramer's thinking, and not necessarily EPS.

Ultimately, "What you need to do is figure out what the growth rate is - figure out how fast a stock is growing, then calculate the trajectory," he said

It's a complex process, but the first step is relatively easy – get a handle on revenue. It's one of the best measures of growth – EPS can be misleading.

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