Your Earnings Cheat Sheet
Earnings season is fast approaching. Many of you will have been through several of these before but for some, it will be an entirely new experience.
Here at MyWallSt, we have a mixed view of the quarterly earnings cycle. On one hand, it’s extremely useful for us as analysts to get this level of insight into these companies every twelve weeks. Seeing how a business is progressing and executing on its strategy is vital for us to be able to make well-informed recommendations to our members.
However, as we have noted before, the requirement for companies to go through the reporting ringer four times per year has its downsides. It encourages leadership teams to focus on short-term wins rather than long-term success. This is great for traders who make their money in times of volatility. It’s bad for the long-term investor who is thinking about the next 5-10 years. The London Stock Exchange only requires a report every half-year and many prominent investors, including Warren Buffett, have called for similar requirements in the United States. Keep in mind that if you are going to own a business for ten years, a quarterly report only represents one-fortieth of your ownership of that company — 2.5% of your journey.
Nonetheless, as long-term investors, we should take this opportunity to look at the books of the companies we own (or maybe ones we’re planning to buy) to see how they are executing on their plans. Given the current economic climate, it will also be important to see how businesses are balancing their book in the midst of so much uncertainty. Forward-looking guidance might not be too useful considering we’re looking into a very unclear future thanks to the coronavirus, but as noted in a previous Daily Insight:
“Cash on hand and access to credit will be very important for companies over the next 12 months as we navigate this new unknown. Most of the time we like to invest in companies that aren’t burdened with debt, but in times like this, we want to see plenty of cash in the bank to ensure they will be able to survive this slowdown, particularly with interest rates so low. Competent managers will have ensured that’s the case.”
As always, we provide MyWallSt members with brief overviews of the main earnings news every morning in our Market Headlines, as well as more in-depth insights in Daily Insights like this and the ‘Our Opinion’ section on every stock page. However, if you want to do some digging into a company yourself, here are some of the main things to look out for:
Revenue — also known as the ‘gross income’ or ‘top line’ of a company’s earnings — is the total amount of money earned by a company in the last quarter. Revenue gives the broadest sense of how a company has performed over the past three months and gives the investor a good sense of the demand out there for a company's goods and services. Don’t be surprised to see some huge increases in revenue figures from businesses that are benefiting from the CV-19 pandemic — the work from home stocks, the e-commerce industry, and cloud-based enterprise solutions.
Earnings, profit, net Income, the Bottom Line. Whatever name you give it, the earnings figure is the most important metric released in a quarterly report as they have the most direct impact on the share price of a company.
A company’s earnings figure is the overall amount of money a business has made in the last quarter, including expenses and tax. This means it gives a more detailed reflection of the company than revenue because it incorporates all the money that has come both in and out.
Earnings Per Share
Companies also include earnings per share (EPS) with their earnings report. As the name suggests, the EPS is just another way to consider a company’s earnings figure.
Instead of using a large overall number, the EPS shows exactly how much profit the company earned on every single share they offer. This makes it a useful metric for investors as it shows them the specific impact of a company’s profit in terms of each share you own.
The EPS is calculated by dividing the overall earnings figure by the number of shares outstanding.
So now we know what it means when a company reports revenue, earnings, and EPS. But what do we measure these against?
One of the most common benchmarks used to assess a company’s quarterly report is analyst estimates (often called ‘Wall Street estimates’ either). As you see quarterly reports emerging, you’ll often hear pundits say that a company has either ‘missed’ or ‘beat’ on earnings or revenue. What this means is that the report has either fallen short (missed) or exceeded (beat) the general expectations of the investing community.
These expectations are formulated by analysts who closely monitor the industry or market. Prior to the release of earnings reports, these analysts will pour over cash flows, forecasts, management guidance reports – even general market sentiment — and try to accurately predict a fair target for the company to hit in their report.
These estimates are then collated into a consensus estimate by institutions like Thomson Reuters. This gives a benchmark average that a company is expected to achieve with its earnings report.
These analyst estimates are extremely influential, as a miss or gain on these will usually result in a significant shift in the share price either up or down.
Analyst estimates are the most commonly used benchmarks for revenue and earnings figures, but there are other comparisons used to understand how well a company has performed.
Companies will usually issue their own guidance on what they expect to achieve for the next quarter with each report. This can be used to see if what they achieve every three months is in line with what they expected to achieve. However, there can be a habit of under-promising and over-delivering with some companies here, so these guidelines shouldn’t be taken as gospel. Also, with the current uncertainty over stores reopening and the economy getting back to normal, a lot of companies might decline to provide guidance.
Year-over-year comparisons are also used to show how much a company has grown (or declined) over a 12-month period. This simply involves comparing the results of this quarter with the same quarter a year ago. This is often used in analyzing the holiday quarter (October to December), as the increased sales usually seen at this time can only be fairly analyzed relative to the same period the year before.
One other benchmark that’s often used in the restaurant and retail industries is comparable same-store sales. This refers to the difference in revenue generated by a company’s existing outlets over the quarter compared to a previous quarter. It omits sales from new stores in order to gauge the traffic at established stores or outlets.
Finally, I would recommend picking one or two businesses and listening to their earnings call. I’ve written a piece on the best way to approach this here.