Earnings season gives investors some vitally important insights into publicly listed companies. But what are the key things a novice investor should look out for?
Let’s be honest – there hasn’t been much in the news to celebrate recently. We seem to wake up to a new global crisis every morning that will dominate headlines until… well, until the next one comes along.
Recently – in the midst of all this doom and gloom – there has been increased coverage on the fortunes of various public companies. This isn’t just a welcome distraction however. Talk of earnings, expectations, revenue and guidance are all part and parcel of earnings season.
Peter Lynch has often been keen to remind us that “behind every stock there’s a company.” As investors, it’s sometimes easy to lose sight of the fact that the share prices we follow are a direct consequence of the companies they represent.
Earnings season gives us the chance to look beyond the fickleness of day-to-day stock prices and see in actual terms how these companies are performing.
Earnings season comes but four times a year – namely the couple of weeks when companies release their quarterly reports to the public. Typically, earnings season falls around the months of January, April, July and October.
For investors, these quarterly earnings reports are important as they give you the best indication of how a company has done and how they expect to do in the coming months. The reports will let the public know if the company has performed better or worse than expected, which will inevitably push the share price up or down.
For the novice investor though, these earnings reports can sometimes seem like nothing more than a mass of complicated figures and terms. Even with comprehensive analysis from most major media outlets, you can sometimes find yourself more confused about the state of a company than you were before.
So seeing as we’re in the midst of the first earnings season of 2017, here’s a quick explainer of the main things you should be looking out for in quarterly earnings reports:
Revenue – also known as the ‘gross income’ or ‘top line’ of a company’s earnings – refers to the total amount of money earned by a company in the last quarter. Revenue gives the broadest sense of how much money has been taken in over the past three months, and gives the investor a good benchmark of the inward flow of cash.
There are a few key things to recognize beneath the broad stroke of the revenue brush however, like the difference between operating revenue and non-operating revenue.
Operating revenue is a valuable metric as it shows the consistent flow of money into the company from conventional business activities like sales. Analysts can use the operating revenue figure to sketch out an accurate model of the regular capital that the company can expect to earn.
However, non-operating revenue is much more inconsistent. Non-operating revenue (sometimes called one-time items) refers to money made from unconventional business activities like the sale of a warehouse, lawsuit settlements, or any interest there might be on cash in the bank. Non-operating revenues like this are irregular sources of capital and can end up distorting the overall revenue figure.
Earnings – Profit – Net Income – Bottom Line.
Whatever name you give it, the earnings figure is the most important metric released in a quarterly report as they have the most direct impact on the share price of a company.
A company’s earnings figure is the overall amount of money a company has made in the last quarter – including expenses and tax. This means it gives a more detailed reflection of the company than revenue because it incorporates for all the money that has come both in and out.
Earnings Per Share
Companies also include earnings per share (EPS) with their earnings report. But as the name suggests, the EPS is just another way to consider a company’s earnings figure.
Instead of using a large overall number, the EPS shows exactly how much profit the company earned on every single share they offer. This makes it a useful metric for investors as it highlights the specific impact of a company’s profit in terms of each share.
The EPS is calculated by dividing the overall earnings figure by the number of shares outstanding.
So now we know what it means when a company reports revenue, earnings, and EPS. But what do we measure these against?
One of the most common benchmarks used to assess a company’s quarterly report is analyst estimates. As you see quarterly reports emerging, you’ll often hear pundits say that a company has either ‘missed’ or ‘beat’ on earnings or revenue. What this means is that the report has either fallen short (missed) or exceeded (beat) the general expectations of the investing community.
These expectations are formulated by analysts who closely monitor the industry or market. Prior to the release of earnings reports, these analysts will pour over cash flows, forecasts, management guidance reports – even general market sentiment – and try to accurately predict a fair target for the company to hit in their report.
These estimates are then collated into a consensus estimate by institutions like Thomson Reuters. This gives a benchmark average that a company is expected to achieve with their earnings report.
These analyst estimates are extremely influential, as a miss or gain on these will usually result in a significant shift in the share price either up or down.
Analyst estimates are the most commonly used benchmarks for revenue and earnings figures, but there are other comparisons used to understand how well a company has performed.
Companies will usually issue their own guidance on what they expect to achieve for the next quarter with each report. This can be used to see if what they achieve every three months is in line with what they expected to achieve. However, there’s a habit of under-promising and over-achieving here, so these guidances shouldn’t be taken as gospel.
Year-over-year comparisons (comps) are also used to show how much a company has grown (or declined) over a 12-month period. This simply involves comparing the results of this quarter with the same quarter a year ago. This is often used in analyzing the holiday quarter (Oct – Dec), as the increased sales usually seen at this time can only be fairly analyzed relative to the same period the year before.
One other benchmark that’s often used in the restaurant and retail industries is comparable store sales. This refers to the difference in revenue generated by a company’s existing outlets over the quarter compared to a previous quarter. It omits sales from new stores in order to gauge the traffic at established stores or outlets.
Earnings season is undoubtedly one of the most important times for investors to pay attention as it’s when you get to see in actual figures how a business is performing – good or bad.
It’s also important to pay attention to a company’s quarterly report because of the immediate impact it has on share price. Following an earnings call, you can usually expect to see instant movement depending on how the company performed.
It’s important to remember that these quarterly reports go into a lot more detail than just these few key terms and figures though. You shouldn’t expect companies to perform spectacularly in terms of hard numbers every single earnings season. In fact, a miss on earnings could be due to increased spending on things like research and development – which is good for long-term prospects.
It’s important to take the findings of quarterly reports in the context of the long-term vision of the company. Paying attention to and understanding quarterly reports is important for all investors as it helps them to make sure the companies they have invested in are on the track they want them to be.