What are Earning Reports?
Financial Education Series
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One of the most fundamental principles of being a long-term investor is knowing the balance sheet, cash flow, and income statement of a company. These filing statements truly give the bottom line “meat and potatoes” of how a company is performing, growing, or declining. Every quarter (3 months) a company will announce an update in these statements to the public. This is commonly known as an “Earnings Report” for investors. Earnings for companies usually occur before market open or aftermarket hours and can send the stock moving upward or downward based on news.
So how do you read an earnings report?
To start, let’s look at the two key metrics that are announced at the beginning of the earnings report and usually are the tale of the tape:
EPS (Earnings per share) and Revenue
Earnings per share, or commonly referred to simply as EPS, is the company's net profit (subtract dividends) divided by the # of common shares it has overall. Generally speaking, the higher the EPS the more the company is considered to be profitable. However, a high EPS isn’t the full story on why you should or shouldn’t invest in a company. The EPS is used in the P.E. (Price to earnings) ratio. A common metric to determine whether a company is overvalued or undervalued. P.E. ratio is the price of a share of the stock divided by the EPS.
Revenue (sales) is simply the companies total income from all operations, product sales, goods it provides, etc. Like EPS, revenue doesn’t tell the whole picture of a companies growth or decline. It does not show expenses that can easily offset most of the revenue generated.
Most of the time when you watch CNBC or any other finance television show during an earnings call you will see a companies quarter announced like this:
BREAKING: $AAPL BEATS EARNINGS (beat means outperformed)
EPS: $2.55 vs. $2.26 est.
REV: $58.3B vs. $54.5B est.
Okay, what’s this “est.”? The “est.” is the estimate that many analysts come up with before earnings to predict the growth or decline of a company. In the above example, Refinitiv was the company that came up with this forecast. Often times all the analysts come up with a number in a very similar ballpark and agree together on an estimate. Now we run into our first problem. A company having an earnings beat or miss is dependent on whether or not the company outperforms (has a higher EPS/REV) or underperforms the analysts’ predictions. But what if the prediction is too high and the company matched or slightly underperformed the predictions? Does that mean the company is a bad investment? Not always.
Let me explain. Stocks are often placed in categories: growth, value, momentum, dividend heavy, etc. These categories are subjective and try to explain the nature of a stock. For example, a growth stock is a company that is supposed to double and triple in value in a short amount of time. Their revenue numbers should constantly be higher and higher every quarter by large percentages. Oftentimes recently growth stocks are in the tech sector and burn a lot of cash (expenses are high) in order to have this tremendous growth. The double-edged sword is that if they even match earnings predictions it can cause their stock to momentarily fumble. Value/large market cap stocks aren’t expected to have such massive growth in revenue and EPS per quarter because the bigger your company is the harder it is to have exponential growth. The problem with these classifications of companies is it’s entirely subjective. One person thinks a company is a growth company and another person sees it as a value company. All in all, you are using EPS and Revenue numbers to build a base on why you should invest in a company NOT be the sole reason.
Moving more in-depth - you can use prior earnings to compare revenue and EPS growth. Often times it is much easier to extrapolate this data using percentages. One of the easiest ways to see this spelled out is on Yahoo Finance. You just have to type in the name of the stock and click on the stock’s profile. Generally, I like to head straight over to “statistics” because this will give a great outlook. Here is an example.
In the “financials” column it is very easy to get a picture of the last couple of years of the companies numbers. Here we can see revenue numbers over the years for $AAPL.
Moving forward, during an earnings report the company doesn’t just announce its EPS and revenue for the quarter. It gives out practically all financial data for the given quarter. It is important for serious investors to not just look at the EPS and revenue of a company because it more than likely does not tell the whole picture. For example, $TSLA recently “beat” earnings with a revenue and EPS beat. However, when the financials were released people realized that they only were profitable for the quarter because of accounts receivable and… look I could write a whole email about this story itself, long story short $TSLA is receiving large amounts of money from the government simply because they are an electric car company and that is allowing them to be profitable. If you only read the EPS and revenue numbers when announced you would not have picked up on this hot button issue.
Another thing that happens after financial statements are announced is the CEO of the company goes on an earnings call to talk about the companies quarter and future outlook. The company can give guidance which is a fancy way of saying what it believes how it will perform next quarter. Lisa Su the CEO of $AMD was one of the few CEOs of the tech industry who actually gave guidance for Q2 when all other companies opted out due to COVID. This was glossed over and not talked about in the news but this was something that stuck with me. I tweeted my head off about how confident Su was in the next quarter for AMD and I bought more and more shares. Well, $AMD Q2 crushed earnings and the stock has soared since. This small detail is something that long-term investors have to hone in on. EPS and revenue don’t always predict everything. In the future, I will do an email on whether or not I believe someone should trade/buy/sell, etc. around earnings but for now, I hope you learned a lot during this earnings report 101 newsletters.
I will finish this email off with one of the greatest investing quotes of all time by the legend Peter Lynch:
“Know what you own, and know why you own it”
― Peter Lynch, One Up On Wall Street: How to Use What You Already Know to Make Money in the Market
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