What is Earning Potential?
Earning potential often refers to the top salary for a particular field or profession. In the finance world, the meaning is not much different: earning potential is the biggest profit a company could potentially make.
How Does Earning Potential Work?
Let's assume Company XYZ sold $200,000,000 of widgets last year and made a profit of $15,000,000. Widget technology is changing rapidly, and Company XYZ not only has the brightest minds in the industry to take advantage of this technology, it also expects to be the first company in the industry to implement the technology, which roughly halves certain production expenses. Thus, analysts estimate that Company XYZ has another, say, $12,000,000 of earning potential.
Why Does Earning Potential Matter?
Earning potential is really an indication of the possibility of dividends or stock price increases. After all, when a company has greater earning potential, it essentially has a pot of untapped money. Investors who realize this can often pick up shares of the company cheaply -- and then ride the stock up and/or collect bigger dividends as the company taps into that earning potential. In turn, earning potential heavily influences the expected growth rate variable found in so many financial calculations. The risk, of course, is that the company does not realize the expected earning potential.