Review the cash flow statement to see if the company is earning cash from continuing operations^[12]. Companies might have negative cash flow but are still able to show positive net income^[13].

Financial Risk Factors

Once you have a sense of a company’s financial health, it’s time to check out the risks that it might be facing in the coming quarters. Move on to Part II (Other Information) and check out Item I (Legal Proceedings).

If a company has outstanding lawsuits, it has to report them along with a brief description of the lawsuits. The company won’t necessarily attach a price tag to a particular legal problem, so you will want to examine the nature of the lawsuit. Consider the potential financial impact of the lawsuit compared to the overall value of the company. Many companies face relatively small damage claims each year, but some companies might face a larger expense from ongoing litigation^[14].

Also, review Item 1A (Risk Factors). You may see statements such as “inadequate liquidity^[15] could affect our future operations” or “given the current environment, our operations do not generate sufficient cash.” Consider whether the risks are part of a general market trend, such as lower sales during a recession, or if they are part of a larger problem, such as revenue coming from one or two sources rather than a diversified set of customers.

Earnings reports can be reviewed and interpreted in different ways by different investors. Some prefer skipping the opening sections on financial data to read about management’s take on the market and the risks facing the company. Some prefer jumping right into the numbers and comparing those to previous quarters and years.

The Bottom Line

You don’t have to be an equity analyst to read and understand an earnings report. Although there are many publicly traded companies posting earnings reports each quarter, concentrate on stocks that are of interest to you. Remember that even if the information found in the earnings report makes you avoid the stock, reading the report is still a worthwhile activity. After all, it saved you from making a bad choice.