Many people are unaware of the meaning behind “earnings season” and what it entails. They may understand that these “reports” occur 4 times a year and are similar to the monthly feedback you receive from your elementary school teacher commenting on your classroom behavior and performance.
In this article, we’ll take you through all you need to know when reading an earnings report. Even if you have a financial advisor who manages your portfolio, it is still critical to understand the decisions being made regarding your money, and in order to do so, you should take some time to learn the implications of earnings reports on stock prices and some important terms used in assessing corporate earnings.
Earnings Season & Reports
All public companies must complete a form 10Q, which is released every 3 months. In the report, the firm reveals revenues, expenses, net profit, and other important details from the three main financial statements (balance sheet, income statement, and statement of cash flows).
They then must file this information with the SEC, otherwise known as the Securities Exchange Commission. This allows shareholders to view and understand the quarterly performance of a company.
Companies typically report their earnings (release their 10Q’s) a few weeks after each quarter ends, which is in January, April, July, and October- this makes sense considering most firms actually divide their year up in calendar quarters.
This “season” normally lasts until the end of each month and is at its peak when a majority of companies release their reports simultaneously. Earnings season is far and away the busiest time of the year for financial analysts. As they scramble to update financial models and projections, they see their hours in the office increase significantly.
The Top & Bottom Line
It is essential to understand revenue and net income from a company’s 10Q report. The top line demonstrates the total amount of money a company has made through its sales in a given quarter. The bottom line illustrates the amount of money a company actually made, or its net profit in the preceding three months.
Comprehension of these statistics can be insightful for shareholders, as they can use them to compare income generated from previous reports to determine if there’s been growth or a decline.
Implications of Beating or Missing EPS Estimates
EPS is one of the most important metrics used in an earnings report. The ratio stands for earnings per share, which measures a company’s net income over its total amount of shares outstanding. It is a great indicator of financial performance and is used in estimates to determine if a company has overperformed or underperformed in a given quarter.
Wall Street firms hire analysts who are responsible for keeping up to date with macroeconomic events and use financial analytics to help predict the future price of stocks. Their role is to create projections for revenue and EPS values.
Typically, stock prices will increase if the company’s actual results exceed the average of those estimates, absent of any other external factors. In contrast, stocks can lose value if the company’s actual results are worse than what analysts estimated.
For example, analysts projected an EPS of $.75 for Dish Network Corporated in Q1 FY 2022. When earnings season came around, the company reported an actual EPS of $.68, missing projections by 9.2%. This led to a sharp decline in the company’s stock price from $27.48 on May 5th, to $22.22 on May 6th, as you can see on this chart…
On the other hand, Moderna’s Q1 FY 2022 earnings results demonstrate how reports that exceed average estimates can lead to increases in stock prices. They shattered their EPS predictions of $5.83, reporting a value of $8.58. This led to shares rising by more than 6% in pre-market trading, despite the company’s dismal performance of -21% over the year.
In this chart, taken from Jika.io, you can see the sharp spike in Moderna’s stock price right before May 6th, 2022, as they released their earnings report on May 4th.
What is an Earnings Guidance?
Although not every company is required to report an earnings guidance, it can have large implications on a company’s stock price, potentially even larger than beating or missing analysts’ projections.
Guidance is a prediction for how a company will perform in the next quarter or over a longer time. We sometimes see companies report better than expected EPS or revenue values, and they still drop in value, which contradicts the previous paragraphs’ argument.
This outcome could be attributed to the fact that the report likely contained lower guidance than investors expected. Therefore, when this happens, the company’s financial performance in the previous quarter isn’t that significant if its future is up in the air.
Vice versa, if a company reports a worse-than-expected EPS estimate, it is still possible for its stock to increase in value if guidance illustrates future optimism.
Don’t get me wrong, if you are beginning to follow financial news, reading earnings reports and understanding their implications can be quite confusing. However, hopefully, this guide can be helpful if you are sitting alone or with your financial advisor trying to make sense of the key terms and statistics presented in these writings.