What Is An Earnings Report?
Each publicly traded company is required to file a quarterly earnings report each fiscal quarter. This report is what you hear referred to as an ‘earnings report’ in financial media and in conversations among traders.
However, an earnings report tells you a lot more than just the earnings (income after all expenses, taxes, etc.) the company generated that quarter.
Companies are dictated by SEC guidelines to include specific information like consolidated financial statements, legal information, new company developments, and changes to the capital structure within the report.
Some data you’ll find in an earnings report:
- Income statement: revenue and expenses
- Balance sheet: assets and liabilities
- Cash flow statement: cash inflows and outflows
- Management’s discussion of the financial situation
- Risks to the company that management sees in the future
- Sale of company securities
In the financial media, though, most of the focus gets put on the bottom-line earnings-per-share number, and how it compares to analyst forecasts. An earnings ‘beat’ is when a company’s EPS exceeds the expectations of analyst forecasts. Stocks tend to go up after earnings beats.
The ability to interpret the information within earnings reports is a high-value skill. Analysts at hedge funds spend a good portion of their time reading several annual and quarterly earnings reports to establish an understanding of the business, then build a financial model to value the company.
Arguably the best investor of all time, Warren Buffett, is known to make most of his investing decisions based on the information held within earnings reports. Buffett prefers annual reports, which is the fourth earnings report a company publishes in their fiscal year because they’re generally more comprehensive and have stricter reporting guidelines.
Where To Find Earnings Reports?
All US-listed companies’ reports are published for free on the SEC’s website. You want to look for 10-Q filings to find the company’s quarterly earnings report, and 10-K filings to find the company’s annual earnings report.
Many financial websites publish earnings calendars that report upcoming earnings releases. Most of these are quite simple and perform the same function. A simple Google search for “earnings calendar” will find you many results, although I do prefer TradingView’s earnings calendar over the rest.
To find when a specific company is reporting earnings, simply navigate to the company’s Yahoo Finance page and look for “Earnings Date” on the Summary page.
Earnings Guidance
Companies generally provide a forecast to their upcoming financial performance in their earnings reports. This is called guidance and it’s a driver of stock prices.
The market is quite efficient discounting mechanism, meaning it discounts all current available information, and potential future events, into the current stock price. Guidance is essentially the company’s best guess at tomorrow’s earnings, which can be just as important, if not more important than today’s earnings. They can give us a glimpse of what the future trend of earnings will look like.
Some companies provide relatively accurate guidance, which tends to materialize barring unexpected developments. The market generally rewards this accuracy with trust, and will price in the high likelihood of their guidance materializing.
There’s a tendency for companies to be very conservative in their guidance. They like to under-promise to influence the market’s expectations, leading to an earnings surprise.
On the other hand, some companies prefer to be overly optimistic in their guidance in order to benefit from the short-term price increase. As a rule, these companies tend to be more manipulative than their conservative counterparts.
Earnings Estimates and Forecasts
Larger cap stocks have several analysts covering the stock, paying attention to any new developments and doing their best to value the company to see if it’s undervalued, overvalued, or fairly priced.
A big part of an analyst’s job is to forecast the future earnings of the company. They do this by taking into account the company’s guidance, the accuracy of past guidance forecasts, macroeconomic factors that will affect the business, seasonality, and using their own financial models (like a discounted cash flow analysis) to forecast the company’s growth rate.
It should be noted that most analysts work for sell-side institutions. That means they’re analyzing stocks on behalf of an institution like an investment bank who makes money by selling financial services and products to the buy side (hedge funds) and public companies. They use their sell-side division to draw prime brokerage clientele or underwriting business.
There’s an inherent conflict of interest present in sell-side analysts. Their employer’s interests are not in helping the public invest better, but instead in generating investment banking business.
Let’s take an example. Company XYZ wants need to hire an investment bank to underwrite their secondary offering of shares. Their choice is between two firms, one has a buy rating on their stock, and the other has a sell rating. Which firm do you think XYZ is more likely to choose?
The general consensus among traders and investors is that sell-side analyst’s forecasts don’t hold much value. After all, if they’re able to accurately forecast the market, why are they an analyst and not a portfolio manager? In spite of that, analysts’ earnings forecasts do hold some value when clustered. The data shows that there’s some wisdom in analysts as a crowd, they’re just too optimistic.
How Earnings Reports Affect Stock Prices
Earnings and stock prices are inexorably linked. Earnings is bottom-line, net profit that a company produces after all other expenses, they’re what drives prices at the end of the day. Several studies have shown that the earnings-per-share of a company is the main driver behind it’s stock price, with micro and macro economic factors playing a secondary role.
To give you a visual representation of this, here’s a daily chart of Netflix, a company that’s had many earnings surprises and misses. Look at the spike in volume and volatility after earnings reports are released (marked by a red E on bottom scale).
Final Thoughts
Earnings reports are the most important filing a company makes. It provides all of the information that is built into investment thesis’, forecasts, and financial models. Without strict reporting guidelines for these reports, the market would be like the wild west.
Some traders stay away from earnings completely. They see it as a binary event they have no edge in forecasting correctly. And even if they could, it would be hard to predict how the market would react. Sometimes a stock will beat its earnings estimates only for the price to decrease as a result.
Regardless of your approach to a company’s earnings release, it’s vital to understand the importance of this document. As a trader, you’re trading the emotions of the shareholders of the stock you’re trading. If nothing else, understanding the sentiment of the most recent earnings report will give you a tip.