Editor's note: Welcome to "Booyah Breakdown," an explanation of certain terms and topics Jim Cramer discusses on his "Mad Money" TV show. Feel free to
So What Are They Talking About?"The growth rate of a company generally refers to the rate of growth of the corporate earnings," says Frank Fernandez, chief economist at the Securities Industry Association. That means that when pundits mention a company's growth rate, they're generally referring to how earnings have grown from one period to the next. To watch Tracy Byrnes' video take of this column,
Some pros will discuss revenue growth or sales growth -- but they should be very clear about that. Ideally, a pro shouldn't use "growth" interchangeably between earnings and revenue without distinction. So you can assume that when someone mentions a company's growth, they're referring to its earnings growth. As a refresher: Earnings are basically revenue minus the cost of sales, operating expenses, taxes and depreciation, etc., over a given period of time. Earnings give investors an indication of the company's potential to expand. So they're important, and the pros like to see how fast they're growing. Calculating an earnings growth rate is actually pretty simple. It's just your basic percentage-change calculation. The accounting folks call it an analytical. You can find a percentage-change calculator on the Web, like
this one , or easily crunch the numbers yourself. You take the earnings-per-share number from the current period, subtract the EPS number from the previous year's period and then divide by the previous period's EPS. Multiply the final number by 100 to get a percentage. Let's try an example. I pulled up Microsoft's ( MSFT) quote on Zacks.com, which has clear EPS and growth-rate info. First, find the most recent EPS. Microsoft will announce its quarterly results on July 20, so we don't have an exact EPS number. We'll just go with the average estimate for now, which is 30 cents. The EPS for the same quarter last year was 32 cents. So now you can plug the numbers into the equation and we calculate the growth rate: 0.3 - 0.32 / 0.32 x 100 = -6.25%. So the pros would say that Microsoft had a 6.25% decrease in quarterly earning growth. Now let's find a yearly growth rate. That means we're going to use EPS numbers that take into account a full year's worth of numbers. The numbers above were quarterly numbers, and therefore only represented the three-month period from April 1 to June 30.
This year's estimated EPS is 1.26. And the EPS for fiscal 2005 was 1.24. So calculate: 1.26 - 1.24 / 1.24 x 100 = 1.6%. That's easy math. And now you know that the pros are only expecting a 1.6% earnings growth for the year. Ideally, you should calculate growth over the last five to 10 years, says Bob O'Hara, vice president of development at investment-education organization BetterInvesting.com. Then you can get a real feel for the path the company has been on. You may also hear the talking heads on TV mention projected growth rates. Those include forecasted numbers. Let's calculate a growth rate for Microsoft's fiscal year ending June 30, 2007. That means we're looking for a year-over-year projected earnings growth rate. We know that this year's estimated EPS is 1.26. The 2007 estimate is 1.39, according to Zacks.com. Since we're going forward to a future point in time, the 2006 number will be considered the previous period. So crunch (or drop the numbers into that percent-change calculator): 1.39 - 1.26 / 1.26 = 10.3. So that means EPS is expected to increase 10.3% by this time next year. That may sound like a big jump from the current year's 1.6% growth rate, but remember, these numbers are useless unless you compare them to the company's peers and get a perspective on what's normal.
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