Out of the many things that can impact a stock's price, a company's earnings stand out as one of the most significant. When considering buying a business, you'd look at its financial records, such as how much money it made, spent on operations, and the resulting profit. Investors buying shares in public companies want this same kind of information.
Understanding how to read a company's earnings report can make you a better investor. This article will go over the parts of an earnings report and how earnings are shown in different ways.
US publicly traded companies have to submit a report on their earnings to the Securities and Exchange Commission (SEC) every three months. It's called a quarterly earnings report and shows how much money the company made, its expenses, and the resulting profit. Additionally, companies must also share their annual earnings report, which details their yearly earnings.
Earnings reports are also known as income statements or profit and loss (P&L) statements.
You can find all earnings reports on a company’s website, usually in the investor relations section.
Earnings reports typically include the following information:
Stock analysts review reports released by companies every three months (quarterly) or yearly (annually). They check if a company meets or misses the expected performance. If a company's earnings are better than predicted by analysts or the company itself, the stock price usually rises. Conversely, if a company doesn't meet expected earnings for a specific period, the stock price might drop.
For instance, Walmart released its financial results on February 18, 2021, and didn't meet analysts' expectations, causing its stock price to fall by over 5% at the opening and ending the day down by 6.48%.
But what exactly do analysts look at to determine if a company's earnings meet or miss expectations?
There are methods to measure a company's earnings that go beyond just stating the total profit. One common way is through a metric called Earnings Per Share (EPS). This helps shareholders understand how much a company earned in a specific time and estimate the value of each share they own.
While no single number can tell everything about a company's finances, Earnings Per Share (EPS) is quite crucial. It reveals the profits that can be shared among shareholders, making it one of the most significant metrics.
EPS is figured out by dividing a company’s net income by its total number of outstanding stock shares.
After releasing quarterly reports, company leaders typically hold an earnings call—a teleconference or webcast. During this meeting, they discuss the company's performance, comparing the actual EPS with the company's predicted EPS and analysts' expectations. They also explain why the company met or missed its expected EPS. These differences can often cause changes in the stock share price.
Another key financial measure taken from a company’s reports is the price-to-earnings (P/E) ratio.
The P/E ratio helps assess a stock's value and can compare companies in the same industry. It indicates if a stock's price is high or low compared to its history. Moreover, the P/E ratio can indicate whether the overall stock market or a specific sector is high or low relative to other periods.
Several factors matter when deciding if a company is a good investment. But generally, when you compare the P/E ratios of two companies, the one with the lower P/E is often seen as a better value.
EPS and P/E ratios come in three main types based on time frames: trailing EPS or trailing P/E (the last 12 months), current P/E, and forward earnings or forward P/E (an estimate for the upcoming year).
Another important metric often highlighted in company reports and discussions about earnings is Earnings Before Interest, Taxes, Depreciation, and Amortization, known as EBITDA. A high EBITDA is typically seen as a positive indication of a company's financial strength. However, a major downside of this ratio is that it doesn't consider certain vital expenses like interest on debt, capital spending, and non-cash costs. Consequently, it fails to provide a full and accurate view of a company's financial situation.
Some earnings reports might conceal more than they reveal.
Sometimes, companies intentionally predict lower quarterly earnings in public reports than they actually anticipate privately. They do this to surpass those expectations and showcase better performance, a practice known as "sandbagging."
Sometimes, companies exaggerate their financial health, which can mislead investors and lead to serious consequences. Enron, once a major U.S. corporation, provides a famous example. They inflated their assets and earnings through accounting tricks. Eventually, investigations revealed the truth, causing their stock price to plummet from a high of $90 to less than $1. This led to huge losses for investors and Enron went bankrupt in 2001.
In today's world of abundant online investment advice, emotions often influence decisions. It's wise to take a careful approach, analyzing earnings reports thoroughly before making investment choices that suit your needs.
