What Is an Earnings Announcement?
An earnings announcement is an official public statement of a company's profitability for a specific time period, typically a quarter or a year. An earnings announcement typically occurs on a specific date during earnings season and is preceded by earnings estimates that equity analysts issue. If a company has been profitable leading up to the announcement, its share price will usually increase up to and slightly after the information is released.
Understanding Earnings Announcements
Because the earnings announcement is the official statement of a company's profitability, the days leading up to the announcement are often filled with speculation among investors. Analyst estimates can be notoriously off-the-mark and can rapidly adjust up or down in the days leading up to the announcement, artificially inflating the share price alongside speculative trading.
Earnings Announcement and Analyst Estimates
For analysts valuing a firm's future earnings per share (EPS), estimates are arguably the most important input. Analysts use forecasting models, management guidance, and other fundamental information on the company to derive an EPS estimate. For example, they might use a discounted cash flows model or DCF.
DCF analyses use future free cash flow projections and discount them. This is done using a required annual rate to arrive at present value estimates, which in turn is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity could be a good one.
DCF = [CF1/(1+r)1] + [CF2/(1+r)2] + ... + [CFn/(1+r)n]
CF = Cash Flow
r= discount rate (WACC)
Analysts may also rely on fundamental factors outlined in the management discussion and analysis (MD&A) section of a company’s financial reports. This section provides an overview of the previous year or quarter’s operations and how the company performed financially. It digs into the reasons behind certain aspects of growth or decline in the company’s income statement, balance sheet, and statement of cash flows. It discusses growth drivers, risks, and even pending litigation. Management also often uses this section to discusses the upcoming year by outlining future goals and approaches to new projects, along with any changes in the executive suite and/or key hires.
Finally, analysts may take into account external factors, such as industry trends (e.g. large mergers, acquisitions, bankruptcies, etc.), the macroeconomic climate, pending U.S Federal Reserve meetings and potential interest rate hikes.