In the second installment of Rubicoin’s Practical Investment Series, we take a look at how an earnings report can give you a good overview of a company you are considering investing in.
Welcome to Rubcoin’s Practical Investing Series, designed to give more advanced users the tools they need to form their own opinions on individual stocks.
As we get stuck into earnings season, it seemed appropriate that this week we take a look at earnings reports, and how you can get a quick overview of how a company is performing.
Every three months, all public companies are required to release a detailed report on how the business has performed over the previous quarter. This includes releasing all of the financial statements that we covered in the last post in this series, as well as management’s comments on the company’s performance.
Quarterly reports tend to be much shorter than annual reports, which are only published once a year. However, they can still be difficult to navigate.
For better or worse, Wall Street has come up with three metrics that can briefly summarise these reports.
The Three Metrics
Wall Street analysts make estimates for how the companies they follow will perform. The average of these estimates typically acts as a benchmark for the company’s performance.
The three metrics analysts focus on are revenue, earnings-per-share, and guidance. All articles about a company’s earnings report will typically mention these three figures.
- Revenue – The Top Line
Revenue is the amount of money a company has taken in over the period through selling products or services. It does not take into account any money earned from interest or financial activity. A company in growth mode should be seeing this figure increase year over year. A company that is seeing flat or declining revenue is probably past their period of high growth, or is experiencing a slump in sales.
- Earnings-per-share (EPS) – The Bottom Line
Earnings-per-share is the amount of money the company managed to keep after paying all their expenses and taxes, divided by the amount of shares outstanding. EPS shows how good the company is at controlling costs and maintaining profits.
EPS must be considered in relation to the price of the stock. For example, a company with a $10 stock that is earning $1 per share is returning 10%. A company with a $20 stock that is earning $1 per share is only returning 5%.
Unlike revenue, EPS can be easily manipulated through various accounting methods. For example, a company could greatly cut its research and development costs in order to pump up their EPS figure.
Some companies (not all of them) will give investors guidance into what they think the company’s revenues and earnings will be for the next quarter or the full year. Wall Street measures management’s guidance against their forecasts and may readjust their future estimates.
So why don’t we just use management’s guidance as a benchmark instead of Wall Street’s?
Management tend to have a habit of downplaying their own guidance – a classic case of underpromise/overdeliver. Wall Street analysts know this, and so they tend to take all management guidance with a pinch of salt.
Other investors completely ignore Wall Street’s estimates and are more concerned with seeing managment meet its own targets.
Be on the lookout for companies that continue to miss their own guidance figures. This is a sign that management have a poor vision of the company’s future challenges, or that they are far too optimistic about future sales.
Getting an Overview
These three figures are so ubiquitous in the world of investing that an earnings report of well over one hundred pages could be summarised in a tweet.
For example, last week Boston Beer Company reported their earnings. This is how one could summarise that report:
Boston Beer: Rev. $244.8M vs. Est. $238M, EPS $2.06 vs. Est. $1.94, Sees FY16 $6.40-$7.00 vs. Est. $6.67
So what this says is that Wall Street expected Boston Beer to make $238 million in revenue this quarter, but they actually made $244.8 million. In the financial world, we say they “beat” on revenue.
Wall Street estimated they would earn $1.94 per share, but they actually earned $2.06 per share. So Boston Beer “beat” on earnings-per-share as well.
Finally, Boston Beer have said they expect to make between $6.40 and $7 per share for the whole year 2016. That’s pretty much in line with Wall Street’s average, which was $6.67.
You’ll find these little summaries posted on Twitter for almost every company listed on the NYSE and NASDAQ:
And while these brief earnings snippets don’t give you all the information you need to make an investment decision, it’s good to be able to see how different companies are performing, and could lead you to investigate a company further.
However, always keep in mind that earnings reports aren’t everything. A bad earnings report here and there will never be the downfall of a great company. Long-term investors should act accordingly and focus on the long-term outlook of a company rather than worrying too much about the quarter-to-quarter performance.
People always overestimate the short term and underestimate the long term.
If you found this helpful, why not read the next in our Practical Investing Series – “Gross Margins”