If you've been keeping an eye on financial news lately, you may have noticed some familiar names making waves: JPMorgan Chase, Wells Fargo, Goldman Sachs, PepsiCo. But why are they in the spotlight?
Well, it's earnings season! That is, the period after every quarter when several publicly traded companies issue their quarterly earnings reports, giving us a sneak peek into their financial performance. Fresh off the press, these companies recently released their earnings reports for the last quarter, and the results are in. JPMorgan Chase, Wells Fargo, and PepsiCo all beat Wall Street estimates, while Goldman Sachs is set to report its “worst quarterly earnings in years”.
If you’re wondering how to get in on all the action this earnings season, here’s a breakdown of quarterly earnings reports, detailing what they contain, what their impact is, and how to read them.
A quarterly earnings report is a report issued by a publicly traded company that provides information about the company’s financial performance in the most recent quarter. This includes information on its expenses, sales, and profit for that quarter.
This report may also offer a comparative analysis, drawing comparisons to the previous year's corresponding quarter or even the preceding quarter. Hence, it is an essential tool for investors, analysts, and stakeholders to:
- Evaluate a company's financial health
- Make informed decisions
- Understand its overall performance trajectory
Among other things, these reports contain three key financial statements:
Companies are required to file these reports on Form 10-Q after the first three quarters (more on that below). At the end of the year, they submit Form 10-K, a comprehensive report on their annual performance.
Mandated by the Securities Exchange Act of 1934, all publicly traded companies are required to file Form 10-Q with the Securities and Exchange Commission (SEC) after the completion of each quarter (for the first three fiscal quarters of the company’s fiscal year).
Companies file these shortly after the quarterly earnings results are released to the public. These earnings reports (which contain unaudited financial statements among other things) provide a more comprehensive report on a public company's financial performance in a specific quarter and support the quarterly earnings results conveyed to the public.
The filing schedule for Form 10-Q could vary based on a company's fiscal year, but most companies submit three 10-Q reports annually. As mentioned earlier, Form 10-Q is filed for the first three quarters; it is not filed for the last.
This is because at the end of the last quarter, companies must submit Form 10-K, a report that offers more comprehensive information compared to the 10-Q.
The Form 10-K annual report offers a thorough view of a company's business operations and financial status for the preceding year and contains audited financial statements.
Anyone can access a company’s 10-Q or 10-K. All you need to do is:
- Go to the SEC's EDGAR database website.
- Use the Search feature to find the particular company you're interested in.
- Under “Filing category,” select “All annual quarterly and current reports.”
- Under “Refine search results by” on the left side, select Form, and choose “10-K” or “10-Q” depending on the report you want to view.
Alternatively, you can look for them on the company website. Most companies upload their press releases, financial statements, and 10-Qs/10-Ks on their websites.
It typically contains the following key components:
- Revenue: This section outlines the total income generated by the company from its primary business operations during the quarter. It includes sales revenue, service revenue, and any other sources of income.
- Expenses: Here, the report breaks down the various costs incurred by the company to conduct its business operations. Expenses may include the cost of goods sold, operating expenses (e.g., salaries, marketing, and administrative costs), research and development expenses, and other expenditures.
- Income statement: Also known as the profit and loss statement, it shows the company's expenses, revenue, gains, and losses.
- Earnings per share (EPS): EPS is a critical metric for investors, representing the company's net profit divided by the number of outstanding shares. It provides an indication of a company's profitability on a per-share basis.
- Balance sheet: This section displays the company's assets, liabilities, and shareholders’ equity at the end of the quarter, offering a snapshot of the company's financial position.
- Cash flow statement: The cash flow statement tracks the inflows and outflows of cash during the quarter, providing insights into how the company manages its cash and liquidity.
- Management discussion and analysis (MD&A): In this narrative section, the company’s management offers insights, explanations, and analysis of the company's financial results, identifying key factors that influenced the performance during the quarter.
- Comparative analysis: Companies often include comparisons with previous quarters or the same quarter from the previous year, giving stakeholders a sense of the company's performance trends.
- Key performance indicators (KPIs): Companies may include specific KPIs relevant to their industry, such as customer acquisition cost, customer churn rate, or gross margin, to provide additional insights into their operations.
- Guidance: Some reports include the management's outlook for the future, offering projections and expectations for the next quarter or beyond.
- Other information: This includes any pending legal proceedings against the company, risk factors, such as liquidity issues, etc.
Investors rely on quarterly earnings reports as a yardstick to gauge a company's potential as an investment. Once companies release their quarterly results, investors and analysts compare the actual earnings revealed in the reports to the expected earnings, that is, the “earnings estimates” (think of earnings estimates as quantified expectations).
Typically these actual numbers are compared with the consensus estimates, which are the average of the earnings estimates that financial analysts put together.
Generally, analysts also track the trends in the ratios that they extract from quarterly earnings reports over time as opposed to focusing solely on individual data points from the latest report.
The periods leading up to and following the release of a company’s earnings report are pivotal for monitoring a company's stock price:
- If the company beats its earnings estimates, the stock price will typically (not always though) experience a significant surge.
- On the other hand, if it misses its earnings estimates, the stock prices will decline or stay the same.
It can be said that a company's ability to outperform earnings estimates set by analysts or the company itself is often more significant than its year-over-year earnings growth. Failing to meet or exceed pre-release estimates can lead to a sell-off of the stock. Thus, the ability to beat earnings expectations becomes a pivotal factor for a company's success in the market.
While the deluge of numbers and information that come with quarterly earnings reports can be alienating, you can understand these reports once you know where to look and what to look at.
You could take different approaches to analyzing a report; you can choose to analyze the financials or skip that and focus on what the management has to say about the company, the market, risks, etc.
But by analyzing the financials, you can get a clear picture of the company's progress compared to the previous quarter or the same quarter in previous years.
- Earnings per share
Earnings per share (EPS) serves as a gauge of a company's profitability on a per-share basis, obtained by dividing its net profit (excluding dividends) by the total number of outstanding shares. It represents the portion of a company's profit allocated to each share.
The formula for EPS is:
EPS = Net income / Number of outstanding shares
EPS is an important metric for investors because it helps them understand how much profit a company is generating per share and more easily compare profitability between different companies. A company with a higher EPS is generally considered more profitable on a per-share basis than a company with a lower EPS.
Additionally, EPS is frequently used in various financial analyses, such as price-to-earnings (P/E) ratio calculations, which help investors determine the relative value of a company's stock compared to its earnings. P/E ratio is calculated by dividing the current share price by the earnings per share (EPS).
You will find revenue in the income statement, sometimes labeled “net sales” or “consolidated net sales.” You need to delve deeper to identify the reasons behind changes or any emerging patterns that you notice. You can also assess how the competitors performed in comparison.
However, while it may have its merits, this metric may not be an entirely accurate or complete indicator of a company's success, as it neglects to consider the expenses involved in generating those sales (rent, logistics, personnel, etc.).
When it comes to poor revenue, you must keep certain considerations in mind, without immediately jumping to conclusions:
- If the sales have failed to grow, this could be indicative that the company is not generating sufficient new business.
- It could be because the expenses associated with sales have increased.
- The lack of growth could be attributed to certain unforeseen market risks (take Covid-19 for example). If yes, you need to see if the company has remained competitive despite these circumstances.
Upon further analyzing the income statement, you will come across operating income and net income, or the “bottom line.” However, it’s important to remember that a company with negative net income is not necessarily performing poorly. Some businesses require several years to become profitable, and this is perfectly acceptable as they lay the foundation for a more robust, profitable future.
- Balance sheet
Balance sheets contain information about a company’s assets, liabilities, and shareholder equity. Companies that accumulate excessive debt may encounter difficulties, particularly during times of tightened credit markets or economic downturns. Therefore, analyzing this section is crucial. For instance, examining the current ratio (current assets divided by current liabilities), or its ability to pay off short-term obligations or current liabilities, helps identify any potential liquidity concerns.
- Cash flow
Cash flow refers to the total amount of money that enters and exits a business. A positive cash flow can indicate that a company:
- Has more liquid assets
- Can pay off its obligations
- Can cover its expenses, etc.
- Earnings guidance
Earnings guidance refers to the information about the company’s anticipated future performance. In this section, you can see the forecasts of revenues, expenses, margins, and earnings. Moreover, the company's management outlines its forthcoming trajectory by defining both short-term and long-term objectives. This will help you establish expectations for forthcoming financial quarters.
- How did the company fare financially in the last quarter, and what were the driving factors of its performance?
- How does the company's current performance compare to previous quarters, such as one quarter or one year earlier? Are there discernible patterns in the earnings outcomes, and what are the underlying reasons driving them?
- Have the revenues improved or declined?
- Where are the company's revenue streams originating? Identify the areas of financial strength within the company. Analyze which products or services are excelling or underperforming and explore the reasons behind their respective outcomes.
- Are costs being managed effectively? If expenses are high, what are the causes?
Quarterly earnings calls, also known as earnings conference calls, are conference calls that take place shortly after a company releases its quarterly earnings report.
On this call, the company communicates its quarterly financial results and business performance to investors, analysts, and the general public, which gives these key stakeholders the chance to gain valuable insights directly from the company's management team.
During the earnings call, the company's executives, including the CEO, CFO, and other top management personnel, discuss:
- Financial highlights (they cover the key aspects of the quarterly filed Form 10-Q or annually filed Form 10-K)
- Operational achievements
- Challenges faced
For investors and analysts, these calls are crucial events; they get to ask questions and seek clarifications about the company's performance and future direction. This, in turn, helps them gauge the company's health, growth prospects, and alignment with market expectations.
Yes! Earnings calls are usually open to the public, and participants can listen to the live conference call or access the recorded call later. Additionally, companies often provide transcripts or summaries of the earnings call for those unable to attend in real time.
Despite the transparency that quarterly earnings reports offer, there has been some debate regarding its overall efficacy - whether the costs outweigh the benefits, whether it makes more sense for public companies to report on their half-yearly earnings, and so on.
A 2018 research paper titled Should U.S. Companies Adopt Semi-Annual Reporting? An Analysis of Quarterly Reporting Requirements and the Practice of Earnings Guidance published by Brown University discussed some of the main points of criticism leveled against quarterly earnings reports:
Short-term perspective: The increased frequency of reporting may encourage short-term perspectives in both management and investors by shifting the focus from long-term strategy to short-term gains.
Guidance issues: Guidance is a subjective and non-standardized practice, influenced largely by a company’s management. Risk-averse management and boards may prefer conservative estimates, which may allow the company to surpass Wall Street estimates upon release, resulting in a positive impact on the stock price.
Whisper numbers: The existence of whisper numbers, unofficial/unpublished earnings forecasts among finance professionals, can further complicate matters.
Costs: The costs of quarterly reporting, which include payments companies make to external professionals like lawyers, auditors, tax experts, IR/PR consultants, and service providers are quite high and are ostensibly higher for the fourth quarter - where Form 10-K is to be filed.
- A quarterly earnings report is a report issued by publicly traded companies, providing information about their financial performance in the most recent quarter. It includes expenses, sales, and profits.
- The report contains three key financial statements: balance sheet, income statement, and cash flow statement.
- Companies are required to file Form 10-Q with the SEC after the first three fiscal quarters. It is a comprehensive report on the company's financial performance in a specific quarter.
- Form 10-K filed after the final quarter is an annual report that provides a thorough view of a company's business operations and financial status for the preceding year.
- Investors and analysts rely on quarterly earnings reports to gauge a company's investment potential. Stock prices can be affected positively or negatively depending on whether the company beats or misses earnings estimates.
- Understanding key financial factors like earnings per share (EPS), revenue, profit, balance sheet, and cash flow can help analyze an earnings report effectively.
- This section of the report provides information about the company's anticipated future performance and outlines short-term and long-term objectives.
- After releasing the earnings report, companies hold conference calls (quarterly earnings calls) to communicate financial results, business performance, and prospects to investors and analysts. Earnings calls are usually open to the public, allowing participants to listen to the live conference call or access the recorded call later. Transcripts or summaries are often provided by companies.
- Some critics argue that quarterly reporting may encourage a short-term perspective and may result in higher costs for companies.
Earnings season doesn’t have to be boring or alienating. You can start by learning how to understand financial statements, which as the SEC itself says, is not “rocket science.” You’ll soon see that with every report you analyze, you gain a deeper understanding of the financial jargon, key metrics, and performance trends.
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