Net Income

What is net income: Net income, also sometimes known as net profit, is a company's earnings after all costs, interest, depreciation, taxes, and other expenses have been deducted. It's also called "bottom line" because it's the final item on an income statement. The net income formula is as follows:

Net income = Revenue - Operating expenses - Interest - Depreciation - Taxes - All other expenses

Net income is an important metric in investing because it helps determine a company's earnings per share. When companies report their quarterly or annual results, they do so in the form of earnings per share. Earnings per share is simply the amount of net income for each share in the company. Its formula is:

Earnings per share = Net income / Number of shares outstanding

Net income as an investment metric

Even though net income and earnings per share are widely used on Wall Street, they may not be the best gauges of a company's performance. There are any number of factors that could affect a company's bottom line. An inordinately high tax bills could artificially suppress net income. Excessive depreciation costs could reduce the number. Even interest payments or one-time expenses could give you a net income number that isn't necessarily reflective of a company's true performance.

Net income is a good metric, but it should be used as a piece of the puzzle; not as a definitive criteria for judging a company's investment potential. You may also want to look at revenue to determine whether a company is growing its customer base. EBITDA, which stands for "earnings before interest, taxes, depreciation, and amortization," is a great metric for analyzing pure operational efficiency without considering taxes, interest, and other financial factors.

Net income for tech companies

The importance of net income as an investment measurement depends on the industry being analyzed. In traditional industries with large, established companies, net income may be important. The expectations for those companies are that they show signs of profitability. For example, a poor net income result for Procter and Gamble (PG) could be a very bad thing.

In the tech world, though, net income may not be as important. Why? Because many tech companies are so new that they're not yet profitable. Investors are okay with the lack of profitability because they are more focused on the bigger picture. They want to see the firm grow, add customers, and improve its product. They trust that if those things happen, profitability will eventually follow.

Yelp stock price chart
Figure 1: Yelp stock price chart by Amigobulls

For example, Yelp (YELP) has never had positive net income. However, the Yelp stock price has increased nearly 136 percent over the past two years (Mar, 2012 to Nov, 2014). Investors have prioritized other metrics like revenue, which has more than doubled from 25.8 million in 2009 to 232.98 million in 2013. As revenue and margins improve, positive net income will eventually come.

It's important to know the net income definition and understand how net income works. However, don't just focus specifically on net income, but also check for other parameters like revenue in the financials.


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