INVESTING

Why Company Earnings Matter to Investors

Of the many variables which can influence the price of the stock–potential expansion, changes to the company’s leadership, stock market mood, adrenaline reports, and dozen other factors–perhaps the most crucial and obvious is the company’s earnings.

If you are considering purchasing an existing company it is recommended to look over its accounting books to examine multiple elements. They include the amount of money the company earned in the last year (and likely for a longer period) and how much it was spending operating and how much that was left over–i.e. its profits. Investors who purchase shares of public companies should have the same data.

Understanding the meaning of the earnings report of a company will make you an effective investor. The article below we’ll examine the elements of an earnings statement and look at the various ways earnings are reported.

 

What Is an Earnings Report?

Companies that are publicly traded in the US must submit an annual earnings report in the form of an earnings report to the Securities and Exchange Commission (SEC) every three months. 1 This is called the quarterly earnings report and it provides the amount of the company’s earnings were as well as the amount it spent, and also how much money is left. The companies are also required to disclose what they earned each year in their annual report of earnings.

Note

Earnings reports are also referred to as income statements, or profits and losses (P&L) statement.

All earnings reports are accessible on the website of a company typically within the investor relationssection.

Reports on earnings usually contain the following details:

  • Basic financial and company details:Where the company is located, the location of its headquarters, earnings and cash flow during the period as well as an account of balance
  • Evaluation of the management team: A synopsis of the performance of the company during the quarter or the year, in comparison to the performance of the previous quarter as well as during the same time frame in the previous year. The section also contains the company’s future plans, which are often referred to as “guidance.
  • Quantitative and qualitative disclosures The SEC requires that companies disclose details about their accounting practices, in addition to determining the quality and quantity of information on the risk of market exposures. 
  • Methods to ensure that the accuracy of information: A list of the efforts undertaken by the company in order to adhere with the standards for accuracy.

 

Understanding Earnings

Analysts review annual and quarterly reports to determine if companies are meeting their expectations and whether it is in the right direction for growth. If earnings from a company during the quarter exceeded analysts’ expectations or the company’s own forecast earnings, its price typically rises. If a company isn’t able to meet the expectations of the expected earnings for the quarter, it could cause the price of the stock to decline.

For instance on February. 18 2021 Walmart released its financial results for the final quarter and for the entire period of the calendar 2020 in the early morning hours before the market opened. 3 The company’s earnings were not as anticipated by analysts and the price of its stock fell. 4 Walmart’s stock price that day was down just over five percent when as compared to the previous day’s close. It ended the day trading down 6.48 percent. 

But what are the metrics analysts using when they discuss earnings beats or miss?

 

Earnings Per Share

There are a variety of ways to quantify the earnings of a business that increase the value of simply listing the sum of profits. Earnings per Share (EPS) can be an eminent metric used to help investors quantify the effect on the reporting period’s earnings in order to determine the worth of shares in the company.

Note

While no single number can be a comprehensive summary of a company’s financial situation, EPS is considered one of the most crucial since it reveals the amount of earnings that are distributed to shareholders.

EPS calculates EPS by taking the business’s net income, and divide it in half by amount of stock outstanding.

When an annual report is published executives of the company often discuss the results on the webcast or teleconference often referred to as the earnings conference. The analysts compare the actual earnings to the projected EPS of the company and analysts’ expectations and then discuss the reasons the reasons why the company matched or did not meet expectations for earnings. The differences between projected EPS and actual earnings can cause uncertainty in the stock’s price.

 

Price-to-Earnings Ratio

Another vital financial metric that’s extracted from an organization’s annual or quarterly reports can be that of the cost-to-earnings (P/E) proportion.

A P/E ratio can be an approach to evaluate the stock. It can also be used to evaluate two companies that are in the same field. It is also a method to determine if a stock’s price is either high or low in comparison to previous. The ratio of P/E can be used to determine the extent to which the market (as an entire or in an individual segment) is either high or low in comparison to other times.

Note

Many factors must be considered when determining whether the company is worthwhile to invest in. But, when comparing P/E ratios for two companies which one has the lower ratio is typically the better investment.

Both P/E and EPS ratios can be evaluated in three fundamental time intervals. They are trailing P/E or EPS trailing (the twelve months preceding the year) The current P/E or ahead earnings and forward P/E (the projected earnings for the coming year).

 

EBITDA

Another important metric to be featured in company reports of earnings or earnings conference calls are Earnings Before Interest, Taxes Amortization and Depreciation–or EBITDA. A good EBITDA is regarded as to be a sign of good business financial health. One of the main negatives of this figure is that it doesn’t include things like cash flow from capital investment, interest on loan and expenses that are not cash-based. This means that it doesn’t give a total picture of the company’s financials.

 

When Earnings Reports Can Be Misleading

The earnings reports in certain situations, can conceal more than they disclose.

Note

Some companies deliberately forecast lower quarterly earnings in public reports than they would expect to see privately to give them an opportunity to beat this projection. This is referred to as “sandbagging.” 6

Sometimes companies paint a better picture of their financial standing than what is actually the case. Over-inflated financial statements and misleading investors can lead to the company getting in financial difficulties. The most well-known instances of a business using accounting methods to increase their assets as well as its profits was Enron seventh-largest U.S. company in the year 2001. The year 2001 saw a sequence of events destabilized both the company as well as its price of stock. The SEC started an inquiry into the accounting practices of the company and Enron revised its financial results for the previous four years. The company’s earnings during that time decreased by $591 million and its debt for the year 2000 was up to $658 million. 

The stock price of the company which had increased exponentially — ranging from seven dollars in the 1990s, to $90 at the midpoint of 2000–fell to just $1 by the close in the year 2001. 8 Investors suffered billions of dollars in losses, and Enron declared bankruptcy in December of 2001. 

In the age of constant internet-based investment commentary and advice that is not sought-after A lot of emotions is entangled when making investment decision-making. A more careful approach, which includes studying earnings reports can serve you well when deciding whether an investment is suitable for you.

 

Key Takeaways

  • Earnings are a measure of the net profit of a business for a quarter or fiscal year.
  • Earnings can help investors decide whether a company is priced.
  • Earnings metrics, such Earnings per Share (EPS) and the price to earnings (P/E) proportion, may assist investors in comparing stocks. Earnings can be evaluated in relation to the past performance either in the current year or even future (projected) results.
  • Sometimes, companies provide lower guidelines to meet expectations, thereby engaging into what’s known as”sandbagging.
the authorAaron Krause

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