6 Things To Look For In Earnings Reports

By Jean Folger | February 22, 2012 AAA
6 Things To Look For In Earnings Reports

Earnings reports allow current and potential investors to evaluate a company's financial performance. All public companies must follow U.S. Securities and Exchange Commission (SEC) regulations when filing earnings reports – Form 10-Q for quarterly reports and Form 10-K for annual reports. Form 10-Q is submitted following each of the first three fiscal quarters of each year, and Form 10-K after the fourth quarter.

In addition to these filings, companies typically create an earnings press release – a summary of what is included in the 10-Q or 10-K report. While an earnings press release provides investors with a basic snapshot of a company, investors desiring a more comprehensive and candid look at a company's financial situation should review the SEC filings. Knowing what is included in an earnings report, and which metrics to look for, can help investors more accurately evaluate a company's financial health. (For related reading, see How To Decode A Company's Earnings Reports.)

What Is in an Earnings Report?
Earnings report contains financial and other information relevant to a company's financial situation. The report is broken down into two parts as follows:

Part I. Financial Information

  • Item 1. Financial Statements
  • Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
  • Item 3. Quantitative and Qualitative Disclosures About Market Risk
  • Item 4. Controls and Procedures

Part II. Other Information

  • Item 1. Legal Proceedings
  • Item 1A. Risk Factors
  • Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  • Item 3. Defaults Upon Senior Securities
  • Item 4. (Removed and Reserved)
  • Item 5. Other Information
  • Item 6. Exhibits.

Reading the Report
While the entire earnings report has information that is significant to the investor, certain elements are considered to be of particular importance to investors evaluating the financial health of a company in which they are already invested or that is a potential investment.

Earnings
Earnings refers to the amount of profit that a company generates during a specific period, and is one of the most studied metrics on a company's financial statement. Earnings are an important metric because they indicate the company's profitability.

Revenues
Revenue is the amount of money that a company receives due to its business activities over a specific period. Revenues that continually increase show positive growth, and earnings typically follow.

Expenses
Expenses are the costs associated with conducting business, and include employee wages, leases and depreciation. As a company grows, its expenses tend to increase correspondingly, so increasing expenses are not necessarily a bad thing. However, when expenses continually grow, as a percentage, more rapidly than revenues and profits, then there may be a problem.

Earnings per Share (EPS)
Earnings per share is important in determining a share's price. It is the portion of a company's profit assigned to each outstanding share of the company's common stock. The value, calculated as Net Income - Dividends on Preferred Stock ÷ Average Outstanding Shares, acts as a gauge of a company's profitability.

Management Discussion and Analysis
Part I also contains the management's take on the financial health of the company. This can include an overview, a discussion comparing the most recent quarter with year-to-date performance and previous quarters, information regarding risks the company is facing, and forward-looking statements. Many CEOs will provide an assessment of where they see their businesses headed. These appraisals, whether carefully optimistic or openly pessimistic, can have an immediate effect on the stock's price. (For additional reading, see Can Earnings Guidance Accurately Predict The Future?)

Risk Factors
Part II of the earnings report contains Item I: Legal Proceedings, and this is where any outstanding lawsuits are reports. Many lawsuits are settled out of court as nuisance claims, but major ones can have a negative effect on the company. Item IA: Risk Factors details any unusual risk to which the company is vulnerable, such as risks associated with new business activity or a proposed change in corporate structure. Extraordinary events, such as natural disasters, are typically overlooked by analysts, since they are unlikely to happen again.

The Bottom Line
While individual metrics, such as revenue, earnings per share and earnings before interest and tax, are important, comparing current performance to that of the previous period, and that of the same period during previous years, is essential. A company is a work in progress, and its performance over time can be a good indicator of its financial health, its ability to adapt to changing market conditions, the productivity of its management and its prospects for future growth. (To learn more, check out Surprising Earnings Results.)

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