Each financial quarter, publicly-traded companies submit their earnings to report the performance. Through these reports, shareholders become aware of the company’s net income, sales, earnings per share, expenses, etc.
There are many ways to analyze these reports, but the most common way is to compare the reported figures versus what was expected by the market beforehand. As soon as the reports are public, the market swings into action, and if the numbers are better than expected, the stocks will surely go up and vice-versa.
It is important to mention, however, that earnings reports often don’t present a realistic perspective of the company’s financial situation, as they try to manipulate the result and, ultimately – the stock price. So, it’s important to understand how to analyze earnings reports in order to separate the company’s marketing strategy from reality.
Earnings Reporting
Companies usually issue a press release with highlights from the 10-Q, which is the comprehensive report of a company’s performance submitted quarterly by all public companies.
Typically, the press release contains just a few paragraphs of information, statements from executives, and key elements of interest to investors, such as revenue, net income, cash flow, earnings per share, and dividends.
How to Filter the Important Information?
Within the earnings report, companies release a presentation deck for investors containing mostly financial highlights and successful data from the period in question. This deck, however, is addressed to the investors and almost always is sprinkled with positivity.
The 10-Q is formed by the following components: income statement, balance sheet, statement of cash flows, disclosures, and management’s discussion. The companies are also obliged to disclose all the market risks they are facing.
The 10-Q documents of large companies often tend to be longer than 100 pages. So, reading the earnings press release is a good start to have a basic idea of how things work. But if you really want to make an informed decision, you should get familiar with the 10-Q filing in detail.
The financial information is outlined in the first major section. You should focus on the areas oriented towards revenue, net income, earnings per share, and earnings before interest and taxes (EBIT).
How to Analyze the Report Yourself?
The key questions you should find the answers to while reading the financial figures are:
What was the company’s performance over the last quarter?
How is the performance rated compared to the previous quarter, or to the same quarter in previous years?
Did the revenues improve or plunge on a quarter-to-quarter basis?
Is the cost of sales going up, and is it more expensive to bring in revenue?
The periods of time prior to or after the earnings report is released, are the most important times to pay attention to a company’s stock price. Whether the company meets the expectations concerning earnings targets or not, the stock price would go up or down, accordingly.
Keep in mind that companies could have negative cash flow but still register positive net income.
Always Check Out the Financial Risk Factors
Okay, you already got familiar with the financial health of the company. Now it’s time to check out the potential risks for the upcoming quarters, so focus your attention on Part II (Other Information) and, more precisely – Item I (Legal Proceedings).
If the company has ongoing lawsuits, it is obliged to report them alongside a brief description. Some companies don’t share the lawsuit costs, so you might have to inform yourself about the lawsuit’s nature and the possible impact it may have on the company in terms of overall value.
You can also review “Item 1A” (Risk Factors). And if you see statements like “inadequate liquidity could affect our future operations”, or “given the current environment, our operations do not generate sufficient cash.” it’s better to find out if the risks are part of a general market trend, such as a recession, or is there a bigger problem, like different sources of revenue instead of a diversified set of customers.
In Conclusion
You don’t need to be an expert in equity analysis in order to understand an earnings report. But my advice is to focus on stocks that truly interest you. And most importantly, even if the information you read in the earnings report is ultimately causing people to avoid the stock, you can still take advantage because on CFD platforms, you can invest even if the price goes down. You just have to pick the right direction!