4 indicators worth watching in quarterly earnings reports

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Four times a year, a downpour of quarterly earnings reports drops from the executive boards and financial offices of public companies around the country.

So, grab an umbrella, because the latest storm has started.

Earnings reports announce the revenue, income, and profit or losses of publicly held companies. The companies are obligated to issue them quarterly to current and potential investors and as a 10-Q filing with the Securities and Exchange Commission, the federal agency responsible for enforcing federal securities laws. Second-quarter summaries for the three-month period ending June 30 are going out from tens of thousands of companies right now.

Most of those will contain good news as the Dow, Nasdaq, and S&P have reported consistent gains over the past month, fears of a big Brexit backlash are subsiding, and prospects for the next business quarter are guardedly optimistic – November’s general election outcome notwithstanding.

But finding the important information in a quarterly report amid line after line of corporate vernacular can be dizzying. Having tackled these reports from two sides – first as a newspaper journalist, then at the corporate level – I can tell you that some of the mystery can be difficult for even experienced eyes to unravel. In some instances, only the reports’ authors have the clearest sense of what’s written. That’s because these people must put polish on what could be a dull or dreary three months, while still meeting an obligation to set the record straight.

You can strain your patience and eyesight pouring through these documents. So, skip past the disorienting argot to focus on these key performance indicators:

Cash flow – As in “free cash flow,” or the cash generated from operations minus capital expenditures and dividend payments. This is distinct from EBITDA – earnings before interest, taxes, depreciation, and amortization – which often appears in the bottom third of the report. From a company’s standpoint, EBITDA is fascinating reading, but the real news lies in the cash flow. If it’s positive, that’s a good sign the company can cover its debts and operating expenses.

Earnings per share, net income, and revenue – Combined, these reflect the overall financial health of a company. The EPS reflects how much of a company’s profit is allocated to each outstanding share of stock, net income reflects total earnings, and revenue refers to total earnings from normal business activities. Of course, positive numbers are preferred, but it’s telling whether these numbers fluctuate widely between quarters. The gap between these numbers attests to variations in the …

Margins – These show how much out of every dollar a company keeps. In formula form, two of the most important ones look like this:

  • Gross profit margin = (Sales – Cost of goods sold) / Sales
  • Operating profit margin = Earnings before interest and taxes (EBIT) / Sales

Size matters for both. If the gross margin is high, a company has extra cash to spend on product development and building the business. Rapid decreases from one quarter to the next, caused by such things as higher labor or material costs, may indicate trouble, which the company can mitigate by raising its prices. As for operating profits, a decrease here suggests the company is struggling to control costs.

Earnings per share vs. expectations – Earnings reports reveal not just how a company performed the previous business quarter. Corporate leadership also devotes space to prospects for the next quarter and punctuates them with a quote or comment usually from the chief executive officer or top financial officer. These prospects shape market and media expectations. If the expectations fall short, the company needs to explain why. A deal closing late or a missed order delivery rarely warrant concern. But revenues that buckle under the weight of changing trends, technology, lawsuits, market turmoil, or new technology can prompt investors to scamper away.

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