Dear Mr. Market:
Here we are in the middle of Earnings Season listening to the various talking heads on TV attempt to decipher the plethora of numbers that companies announce. As they spew out seemingly meaningless information how is the average investor expected to make sense of it all? With terms like “diluted earnings, future guidance, write downs, cash infusions and GAAP financial measures” it can certainly be a bit overwhelming! Ultimately investors simply want to know if a company was profitable or lost money for the previous quarter and what expectations are going forward. Why does Wall Street have to make these quarterly reports so confusing and talk over the average persons head?
We will attempt to cut through the ‘financial jargon’ and focus on the core numbers and what investors really need to look at each earnings season. “Creative Finance” is a term that comes to mind as you read through some of the reports that are released by corporate America. Maybe a more accurate phrase would be “you can put lipstick on a pig…but it’s still a pig!” There is certainly a lot of window dressing that takes place each earnings season but the key is to focus on what is truly important and not get lost in the data.
The numbers that are released can have a profound impact on the stock itself as well as the entire stock market. The market usually approaches quarterly earning reports with caution due to uncertainty. If there is one thing the market does not like…it is uncertainty. Companies that hit or exceed their numbers will see the stock typically rise while the market will hammer companies that disappoint. For the larger companies analysts will usually have an expectation of what their numbers should be prior to them announcing their actual numbers. Companies will also often release their own “earnings guidance” in an attempt to set expectations. If an industry leader stumbles with the numbers shared in their earnings announcement the stock itself and the entire industry or sector could suffer.
In the following paragraphs we walk you through the components that are typically found in an earnings report:
The first portion of a company’s earnings report is basically an overview of the company; where they are incorporated, tax identification information, their primary business and the table of contents for the report. Unless you are not familiar with a company you can flip right past these pages.
Part I: Financial Information
This section will typically list the key financial figures and allow you to examine and analyze the quarterly data. While there can be a lot of information, listed below are some key questions to ask and research:
- How did the company perform over the quarter?
- How did the performance compare to the previous quarter or the same quarter over the last few years?
- Is it becoming more expensive to create profits? Look at cost of sales.
- Are revenues improving or declining?
- Review cash flow statements – is the company accumulating cash or using it?
Part II: Other Information
After reviewing the company’s financial health you can check out other risks that will have an impact on the stock. It is important to review any Legal Proceedings; this will list any outstanding lawsuits that the company is facing. They will not put a dollar amount on these in most situations but it can paint a picture of what the future might hold for the company (remember the lawsuits associated with tobacco companies!?).
We would also suggest that you look at Item 1A – Risk Factors. This is the information shared with the SEC (U.S. Securities and Exchange Commission). Companies are required to be honest and forthcoming with information shared in this section. You might see a statement like, “given the current environment our operations do not generate sufficient cash.” It is important to consider if these risks are unique to the company or part of the overall market and economic environment. They could also give insight to any issues that could have a negative influence on the company – Ex: Is the majority of revenue being delivered by a few key relationships rather than from a diversified client base?
As you browse through an earnings report there are some terms that will appear frequently; below we’ve listed a few along with a plain English definition (provided by Investopedia):
Earnings Per Share – EPS – The portion of a company’s profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company’s profitability.
Trailing EPS – The sum of a company’s Earnings Per Share for the previous four quarters.
Quarterly Revenue Growth – An increase of a company’s sales when compared to a previous quarter’s revenue performance.
Net Income – NI – A company’s total earnings (or profit). Net income is calculated by taking revenues and adjusting for the cost of doing business, depreciation, interest, taxes and other expenses.
Trailing Twelve Months – TTM – The timeframe of the past 12 months used for reporting financial figures. A company’s trailing 12 months is a representation of its financial performance for a 12-month period, but typically not at its fiscal year end.
So what does this all mean for you?
Earnings Reports can be as confusing as you want them to be. After reading some analysts reports you will sometimes question if it was written in English! If you have the interest then take the time to look at the criteria that is important to you. Don’t allow yourself to be fall into “paralysis by analysis!” If you don’t have the desire to read through and research all this financial jargon then explore other options:
- Consider working with a fee-only financial advisor that can make sense of these reports and help invest your assets based on your goals and risk tolerance.
- Rather than invest in individual stocks consider other options such as Exchange Traded Funds (ETF’s).
- Look at broad investments that are focused on a sector or specific market-cap.
In closing we would encourage you to remain true to yourself as an investor. Don’t try to become a day-trader or a financial analyst. Invest in what you are comfortable with and what you understand. A key element that many investors don’t take into consideration is to examine and understand the fee structure associated with any investment option – unnecessary fees erode a portfolio at an alarming rate.
We encourage you to contact us at your convenience with any questions or comments. Lastly, if you have a topic you would like us to cover please pass it along!