When it comes to investing in stocks, “buy what you know” is hardly a starting point anymore.
Sure, recognizing or loving a product is a great introduction to that company (e.g., I love Chicken McNuggets so I’m buying shares of McDonald’s), but fandom alone may not be enough to justify purchasing that company’s stock.
There are a lot of factors to take into consideration regarding the financial health and potential prosperity of a company, For example, is this company able to consistently bring in more revenue than they spend?
Luckily, this is information that investors have easy access to via earnings reports.
By learning how to read an earnings report, you could unlock invaluable information about the state of a company over time, as well as come to your own conclusions about whether the company’s stock is a worthwhile buy for you.
Reading an earnings report isn’t always intuitive—there’s a lot going on there. That said, it’s not hard to learn the key numbers and information necessary to make an assessment of a company.
Here are some important elements to look for in a company earnings report.
What Is an Earnings Report?
When you invest in a stock, you are investing in a small sliver of ownership in a publicly traded company. To be publicly traded, companies are required to file quarterly (and annual) financial statements with the U.S. Securities and Exchange Commission (SEC).
These financial filings keep shareholders and regulators apprised of the financial and legal standing of a company. Financial transparency also allows current and potential investors to make decisions about the company through their own analysis and judgment.
Generally, when you hear someone speaking of a general “earnings report,” they are referring to the forms 10-Q and 10-K, which are quarterly and annual financial filings, respectively. Both disclose a company’s revenue, expenses, profit, and other financial information each quarter.
These documents can be dozens of pages long and will have an index at the beginning to help with navigation. Here’s what is included in a typical 10-Q report:
Part 1: Financial Information
• Management’s Discussion and Analysis of Financial Condition and Results of Operations
• Quantitative and Qualitative Disclosures of Market Risk
• Controls and Procedures
Part 2: Other Information
• Legal Proceedings
• Risk Factors
• Other Information and Exhibits
You can find a company’s form 10-Q or 10-K through the SEC’s filings database called EDGAR . There, you can also find other filings, such as 8-K filings, which notifies the public of corporate changes.
Also, know that while each company is required by law to report accurate numbers, the numbers are not necessarily audited by the SEC.
What Is Earnings Season?
Companies reporting their earnings via a 10-Q or 10-K tend to do so in the weeks following the close of each quarter, so the weeks following the close of each March, June, September, and December. This is a very exciting time for investors as dozens of companies report their earnings numbers per day at the peak of each earnings season.
When analyzing statements during earnings season, it’s important to remember that often, one 10-Q filing alone doesn’t tell the whole story. You may find it helpful to compare the most recent report to previous reports to get an idea of a company’s history.
You may also find it compelling to compare against earnings expectations, building a case as to whether this is a company that is growing with a strategic business plan.
How to Read an Earnings Report
Many potential investors will spend a substantial amount of time looking at a company’s financial statements, which make up the first part of the earnings report.
This is arguably the most sought-after part of the earnings report because it states whether or not the company is making money, which might be the key piece of data that investors are seeking.
Here’s what you can find within the financial statements section:
Income Statement: How much money a company made over a period of time. Usually, the current quarter’s information is compared to previous quarters or multiple quarters.
Balance Sheet: What a company owns and what they owe—its assets and liabilities.
Cash Flow Statement: This section details the exchange of money between the company and the outside world over a given period of time.
Statement of Shareholder Equity: Changes of interest for the company’s shareholders over a given period of time. Here, you’ll find information on the value of all outstanding shares along with the potential dividend payment made by the company during the previous quarter(s).
For many investors, the income statement is of particular interest. This document details how much a company earns, how much it spends, and how profitable it is over a certain period of time. These numbers can reveal a lot about where a business is at and where they’re headed.
Here are some important figures you could look for in the income statement:
Revenue: A company’s sales. This is also known as the “top line,” because it sits at the top of the cash flow statement. This figure does not take into account the costs of running a business, so may not be the best indicator as to the overall financial health of a company.
Cost of Revenue/Cost of Sales: Directly under the revenue or sales figure you’ll find a section that details the costs of producing the goods sold, such as production and manufacturing. To be clear, these are not all of the costs associated with running a business, only the costs directly associated with the sale of the product or service.
Below this figure, you will find the section referred to as “gross profit” or “gross margin,” which is the cost of revenue subtracted from the revenue. It is called “gross” because the figure is not net of all costs associated with running a business—only the costs associated with sales.
Operating Expenses: These are the costs of running a business that cannot necessarily be attributed to a company’s operations for a given period. Research and development, marketing expenses, and salaries of administrative personnel are all examples.
Here, it is possible to account for depreciation expenses, such as the wear and tear on assets such as machinery and tools or other assets that are used over long periods of time.
At this point in the cash flow statement, a company may account for adjustments to income due to interest earnings or expenses (such as earning interest in a savings account or paying interest on debts) or income taxes. Sometimes, this information is listed separately.
Earnings: This is a company’s profits, also known as the net income or “bottom line,” because earnings exist at the bottom of the cash flow statement after all costs are subtracted. This is the money that the company made in the previous quarter after all costs of running the business are accounted for. Ultimately, this is going to be the number that most concerns shareholders, as a profitable business model is what attracts many investors.
Not all businesses are profitable all of the time, so it is possible that an earnings number can reflect a loss. When a company is recording a loss, the number is written inside of parentheses.
Earnings Per Share (EPS): While the earnings figure is certainly important, it’s helpful to have some context as to what that means to investors. The EPS calculation divides the earnings figure by the number of outstanding shares to derive a figure that represents what it would look like if those earnings were to be evenly spread across all shareholders.
For example, an EPS number of $1 would indicate a $1 earning per share of outstanding stock. However, a $1 EPS does not necessarily mean that’s what the company pays out to each shareholder.
Instead, it’s a way for investors to compare profitability across businesses within the same industry, to a business’s past profitability, or to expectations for a company’s future profitability. More than anything, it is used as a tool for analysis.
For a more qualitative look at a business, you could take a look at the section titled Management’s Discussion and Analysis. Here, executives summarize both the numbers detailed in the financial statements and what’s going on in the business that might not be outwardly obvious simply by looking at the numbers.
For example, executives could take this time to discuss a merger or other market factors that may have led to skewed numbers for that quarter.
The Effect on Stock Prices
The idea of “earnings per share” being an absolute measure of a company’s performance can be somewhat misleading to potential investors. Yes, it is an important and easy way to compare performance, but it does not necessarily indicate the direction that the stock price is headed.
An improvement in any metric on a balance sheet, including EPS, will not necessarily cause a unilateral move in the price of that stock.
That’s because stocks are for sale in the global stock marketplace, and it’s the buying and selling (supply and demand) of that stock that gives it its value.
Let’s look at a hypothetical example of how this might manifest. Say that analysts forecasted the EPS for a company to come in at $0.80 for the quarter. Instead, EPS came in at $0.45 for the quarter. Because the hypothetical company “missed its earnings estimates,” the open market may react negatively.
Investors may sell their stock, and it could cause the price of the stock to fall.
But this is still a profitable hypothetical company with positive earnings—it’s just not as profitable as analysts had predicted. And so you can see from this example, a number like an EPS is a way to gauge a company’s growth trajectory, but can’t necessarily predict how the market will react.
This may be especially true in the short-term, where the market can shift on sentimental factors.
Of course, there are other intangible elements that aren’t in the earnings report that could have an effect on the future value of the stock. Examples could include brand cache or an unexpected merger or acquisition.
On the flip side, a company’s stock price could take a beating because of a company scandal or legislation that affects the way they can do business. Though important, a company earnings report may not paint a complete picture of that stock.
You’ve done your research and are ready to buy a stock. Congratulations, the hardest part is done. Now, where can you can purchase the stock? This could be done within a brokerage account or on an online trading platform, like SoFi Invest®.
One of the great things about SoFi Active Investing is that there are no trading costs, so you can buy and sell stocks with ease. Plus, there are no account minimums. With SoFi Invest, you don’t have to worry about costs eating away at your potential profits.
If picking your own stocks seems like a job you don’t want, not to worry—there are still some great options for getting invested.
Instead, you could consider buying into a big pool of stocks by using funds such as exchange-traded funds (ETFs). ETFs can help take some of the guesswork out of the process and get you invested in a diversified portfolio with ease.
To pick your own ETFs, you can look to using a service like SoFi Active Invest. For help picking ETFs that match your goals for the money, SoFi Automated Investing has you covered. And no matter which service you choose, you’ll have access to financial planners who can answer questions about your investments and more.
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