How to analyse a company's earnings report

How to analyse a company's earnings report

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Who knew analysing a company’s earnings report could be challenging? A business can report record-high profits yet still see its share price fall. Another might publish disappointing earnings yet see its share price rally on news of an improving outlook. Why? Because markets respond not only to what a company has achieved, but also to what investors expect and what its results suggest about the future.

What is an earnings report?

A company’s earnings report is a document that details its financial performance over a specific period, usually a quarter or a full financial year. The report typically comprises the following elements:

• Income statement
• Balance sheet
• Cash flow statement
• Risk disclosures
• Management’s discussion and analysis

The good thing is that earnings reports are publicly accessible, and interpreting them is not a skill exclusive to equity analysts and financial professionals. Learning how to analyse a company’s earnings reports can be valuable when considering your next steps in trading or investing. Their contents can help you assess whether to buy a stock, hold an existing position, or sell a current holding.

How earnings reports are published

In many cases, companies publish their earnings results through a press release. Because of the concise nature of this format, the press release typically provides a summary of the company's financial performance, highlighting key figures and information of interest to investors, such as revenue, net income, dividends, cash flow and earnings per share.

Companies may also publish an investor presentation that outlines their financial highlights and performance during the quarter. As these presentations are prepared by the companies themselves, they may place greater emphasis on positive developments and achievements. Investors should therefore consider them alongside the company's full financial statements and regulatory filings.

For US-listed companies, Form 10-Q is a quarterly report submitted to the Securities and Exchange Commission (SEC). It is not unusual for large corporations to have 10-Q filings that exceed 100 pages. Investors interested in buying shares in a company can examine its 10-Q filing, as it provides a more comprehensive overview of the company's financial performance and position.

The first part of the filing identifies the company submitting the report and provides details such as the reporting period and the company's registered address. It also includes information about the company's filing status and other regulatory details. The filing typically contains a table of contents indicating the sections and their corresponding page numbers.

Questions to ask when analysing earnings

The next major section provides more detailed financial information, including revenue, net income, earnings per share and, where relevant, earnings before interest and taxes (EBIT). If you are interested in a particular company, you can ask yourself the following questions:

• How did the company perform over the last quarter?
• How did it perform compared with the same quarter last year?
• Did the company report revenue growth, or did revenue decline compared with the previous quarter?
• Are the company's costs increasing, and how are they affecting its profitability?

The cash flow statement is a useful place to assess whether a company is generating cash from its operating activities. In some cases, a business can report positive net income while also recording negative cash flow from operations.

How to identify red flags in earnings reports

One of the red flags to watch out for is the presence of outstanding lawsuits. Companies may be required to disclose material legal proceedings, along with relevant details about the nature of the claims. However, not all lawsuits or potential financial obligations need to be disclosed in the same way. As an investor conducting due diligence, it is always wise to examine the nature of any significant legal proceedings. Do not focus solely on reputational damage; also consider the potential financial impact of a lawsuit relative to the company's size and financial position. Some companies may regularly deal with smaller legal claims, while others could face significant financial losses or operational disruption as a result of ongoing litigation.

Be mindful of terms or statements such as ‘inadequate liquidity’ or ‘weak cash flow’. However, do not interpret them entirely out of context. Assess whether the risks reflect broader market conditions affecting many businesses, such as a recession, or whether they are specific to the company. For example, consider whether the company's revenue depends heavily on a single source or a concentrated group of customers rather than a diversified customer base.

As a prospective investor, you can review and interpret a company's earnings reports to better understand its financial position and performance. Some investors head straight to the figures, comparing them with previous quarters and years, while others take time to read management's commentary on market conditions, as well as the risks and challenges facing the company.

Turn your earnings analysis into a trading plan

When reading an earnings report, the goal is for a trader to gain a more informed perspective about the companies behind market movements. It isn’t about predicting every price reaction, but to understand the evidence, identify risks, and avoid making decisions based solely on headlines.

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