There comes a time in every investor’s career when it’s time to strike out on their own. Rather than listening to others and simply taking their recommendations at face value, it’s important to eventually do your own research and come to your own conclusions as an investor.
Step one in this process: Read the quarterly report.
A company’s quarterly reports offer valuable information for one to become a more informed investor.
And as intimidating as they may seem, these reports are fairly easy to break down… they certainly don’t require you to have an MBA or experience in finance. The key to reading quarterly reports is to focus on only the important aspects of it, and learn to read between the lines on what numbers are saying. Investments will always come with risk, but you can lessen the risk by doing due diligence on the company.
At their most basic level, a quarterly report is a document that breaks down how a particular company performed over the previous quarter. They include financial results, commentary from management on risks, and perspectives on the information given.
It’s worth noting that the term “earnings reports” is interchangeable with the term “quarterly reports.” When investors talk of “earnings seasons,” they’re alluding to certain periods of time companies collaborate to announce their earnings, typically quarters.
The SEC requires companies to post their quarterly reports no later than 45 days after the quarter ends.
The exact layout of quarterly reports can fluctuate, however most of them have consistent topics and sections. While this can cause confusion, focusing on certain areas can help ease the process. Part of understanding a quarterly report is also digesting outside documents and information. Here’s what they typically include:
Revenues, Expenses, and Income: Revenue refers to the total amount of money the company has brought in over the previous quarter. These numbers are referred to in different places throughout the report, but can consistently be found at the top of the income statement. Expenses will be located on the bottom of the income statement, and refer to how much a company spent over the quarter to get the revenues it did.
While high revenue numbers are encouraging, a high net income is what matters. Income refers to how much of a profit a company made, and derives from subtracting the expenses from the revenue.
Balance Sheet: A balance sheet is a snapshot of how the numbers look for a company on a certain day. The ones listed in a quarterly report often are from the final day of the previous quarter. They list everything from company assets to shareholder equity. Balance sheets are important because they also alert you to any company liabilities that could stunt the future growth of the company.
Income Statement: Income Statements are much more extensive than balance sheets. Primarily, income statements list the numbers that make up the revenues and expenses for the company over the previous quarter, as well as their gains and losses.
Management Discussion and Analysis (MD&A): The Management Discussion and Analysis section is where company management explains to investors why the company performed the way they did, as well as future ambitions they have for the next quarter and beyond. While MD&As are worth reading, be sure to take them with a grain of salt. They are not as important as the actual numbers, and where you’ll find a lot of spin and corporate jargon. Often positive outlooks are applied to their commentaries to encourage investors to invest that (or keep investing).
Earnings Per Share (EPS): The Earnings Per Share figure is derived from dividing the number of shares outstanding by the profit from the previous quarter. The number given from this equation tells investors about the company’s profitability. The ESP is one the most important things to evaluate in a quarterly report. A high EPS means your stock should be priced higher (and is undervalued), while a low ESP means the stock is overvalued. Good investors look for companies with upward trending EPS’s.
P/E Ratio: The P/E ratio takes the price per share of the stock and divides it by the earnings per share (EPS). Also known as the price multiple, a P/E ratio of 20-25 is considered average for companies. In short, the P/E shows what the market is willing to pay today for a stock based on its past or future earnings. A high P/E could mean that a stock’s price is high relative to earnings and possibly overvalued. Conversely, a low P/E might indicate that the current stock price is low relative to earnings.
Lawsuits: See if a company has pending lawsuits, and why. Evaluate all the potential lawsuits the company has, and use discretion to consider the potential detriment they could have on the company long-term.
Debt: Taking on too much debt can be a risk factor, and the SEC requires companies to list their outstanding debts in their quarterly reports. Debt doesn’t mean a company is in bad shape, but be sure to understand the reasonings companies have for taking on this debt.
After looking through various aspects of a quarterly report, informed investors need to evaluate the information and numbers given. A good place to start is by comparing the earnings and ratios to the previous quarter. Comparing where they are to where they’ve been is one way to evaluate the growth and investment opportunity of a company.
Smart investors should also consider looking to see how the company did in comparison to the market or sector it is in. If other companies within the sector did well, positive results may not be directly due to them doing things effectively.
The simple fact that you are taking the time to understand how to read quarterly earnings sets you apart from many uninformed investors. Over time with practice, you’ll only get better at understanding a company’s potential and risks.
Push yourself to read quarterly reports from companies you’re considering investing in. The skills you’ll learn from doing so are valuable, and a key part of every good investor’s repertoire. Even if reading them discourages you from investing, you might have just saved yourself thousands of dollars from a bad investment.