Deciphering Earnings Season: Beats & Misses
by Bret Hartman
Earnings season hits Wall Street four times a year. Publicly traded companies will release their quarterly financial statements at the end of each quarter: In the beginning of April, July, October and January.
Stocks typically show more volatility on these earnings releases (either on the upside or downside) depending on how happy investors are with the company’s performance. It’s important to separate perception and concrete numbers when reviewing an earnings report. Reports will typically start by stating what analysts expected the company to earn in terms of earnings per share (EPS), revenue and other business specific measures of profitability.
For example, let’s say analysts expect EPS of $1.00 a share for Company X, and actual EPS come in at $1.10. Your first response to this news is “Wow, Company X outperformed for the quarter!” But before you start celebrating, be sure to read the full report. Yes, Company X did outperform for the quarter based on what select analysts estimated, but remember that analysts’ estimates are only “best guess” predictions. While large company estimates tend to come very close to actual results, you should be weary of estimates for smaller-cap stocks with low analyst and media coverage.
Even though Company X earned $1.10 per share and beat estimates by 10%, we need to look at how this compares on a yearly basis. Let’s say the company earned $1.20 in the same quarter a year ago. This tells us that the Company X’s profit decreased over a year’s time.
Company X happens to be a popular company and is followed my multiple media outlets. Some headlines will read, “Company X reports earnings that beat all analyst estimates,” while others might read, “Company X shows 8% drop in profit.” So as you can see, investors should do more than read headlines.
For U.S. companies that have business overseas, it’s important to determine if currency rates hurt EPS. If EPS was down 10% for the year, but currency dented earnings by 12%, you can see that the company didn’t perform as poor as it appeared to.
By understanding earnings reports and the company’s current health, you will be able to take advantage of price movements in that specific stock. You won’t have to calculate currency effects or other measures such as impairment charges. This information is all out there within the reports, but be sure to pull out the most useful points. Here are a few questions that you should ask while reviewing the reports:
- Did the EPS for the current quarter go up or down from last year?
- Did the revenue for the current quarter go up or down from last year?
- What are the key contributors to revenue and main detractors of revenue?
- What are the currency effects?
- Is the company cutting capital expenditures (costs/jobs)? If yes, why?
- Has the dividend increased or decreased? (If it has decreased, this could signal a major cash flow problem within the company, etc.)
- Does the company have any impairment to their assets? (Ex: Write-down of oil fields during weak oil prices.)
- Did the company have tax breaks that helped EPS?
- What is the management commentary for the quarter? (Although, commentary from the company’s top management is often biased.)
- How are shares reacting to the earnings reports? (If shares are lower on positive earnings results, it represents a buying opportunity.)
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