How to Decode a Company’s Earnings Reports
The earnings report[1] is the predominant method for a publicly-traded company to report its financial results for a specific period. Investors can use a company’s earnings report to gain insight into how well a company is run and whether the company is performing well.
However, it’s important to note that earnings reports often present a rosy picture of the company’s financial situation. As a result, it’s important to learn how to read and decipher an earnings report so that you can separate the management team’s sales pitch from reality.
Key Takeaways
- Public companies are required to file a 10-Q, quarterly report, annual report, or 10-K, with the Securities and Exchange Commission (SEC).
- The 10-Q is the quarterly report filed by companies that details the business throughout the year.
- The main components of the 10-Q are the income statement, the balance sheet, the statement of cash flows, disclosures, and management’s discussion.
- In addition to analyzing the financial statements, it’s important to analyze any financial risks, such as litigation, that could pose a threat to a company.
Earnings Reporting
Companies typically issue a press release[2] highlighting the contents of the 10-Q[3]. The press release often contains nothing more than a few paragraphs of information, a statement from executives, and outlines of some of the key elements of interest to investors, including revenue, net income, cash flow[4], earnings per share[5], and dividends.
Companies will also release a presentation deck for investors that contains the financial highlights and success from the period. However, the deck is prepared for the investors and typically contains a very positive message.
Form 10-Q, on the other hand, is a no-frills document that is submitted to the Securities and Exchange Commission[6] (SEC). The 10-Q carries more significance for investors because it contains a wealth of information. While elements of the earnings report can fall into the realm of marketing material, companies releasing them cannot fudge the numbers without risking an SEC violation.
How To Decode A Company’s Earnings Reports
The Components of an Earnings Report
Companies are legally required to file a quarterly report, a 10-Q, an annual report[7], or the 10-K[8] with the SEC.
The 10-Q contains financial information including:
It’s not uncommon for large companies to have 10-Q documents longer than 100 pages. For a quick snapshot of the major tenets of what’s going on with a company, reading the earnings press release is a good start. Investors who are interested in buying shares in a public company and want to make an informed decision should examine the 10-Q filing. It is important to note, however, that the financial statements[9] are not audited[10].
The first part of the document outlines which company is filing the report, for what period, what state the company is incorporated in, tax identification information, and the primary business location. The report will then list a table of contents indicating which sections are found on which pages.
The first major section contains the financial information. Key areas of focus should include revenue, net income, earnings per share, and EBIT[11] or earnings before interest and taxes. While the above financial figures are important, make sure to ask the following questions:
- How did the company perform over the last quarter?
- How did the performance compare to the previous quarter, or to the same quarter in previous years?
- Have revenues improved or taken a hit on a quarter-to-quarter basis?
- Is the cost of sales increasing, meaning that it is more expensive to bring in revenue?