Let’s pick up where we left off last week in our discussion of earnings season.
Active traders have shown a preference for earnings per share and net income, but these two metrics don’t tell the full story.1 You can better understand these figures if you also look at the other metrics that are explained below in this article.
Net Income: This figure represents a company’s total earnings, calculated by subtracting costs, interest, taxes, depreciation, and other expenses from the company’s revenue. It indicates how profitable a company was for a specified time period.
Earnings Per Share (EPS): Many investors and analysts believe EPS is the most significant metric that the market uses to derive a company’s stock price. EPS is calculated using formula below.2
EPS = (Net Income – Dividends on Preferred Stock) / Average Outstanding Shares
Price-to-Earnings Ratio (P/E): Calculated by taking a stock’s market value per share divided by its EPS, the P/E ratio can help define a stock’s future value. Higher P/E ratios indicate higher growth in the future is likely.
Revenue: Determined by multiplying a company’s product prices times the quantity of all goods or services sold, revenue is often used as an indicator for a company’s momentum leading into the next quarter.
Earnings before interest and taxes (EBIT): EBIT shows a firm’s operating earnings before interest and taxes but after depreciation. Companies tend to cite this figure before net income and EPS for reporting periods with significant expenditures. Some consider EBIT synonymous with operating income but the Securities Exchange Commission advises not to regard them as such.
EBITDA (Earnings before interest, taxes, depreciation and amortization): Similar to EBIT in that a company might mention it before net income or EPS if there are significant expenditures during a reporting period, but like its name suggests EBITDA calculates earnings before depreciation or amortization are determined. Some consider EBITDA to be synonymous with cash flow figures but technically this is inappropriate.3
Margins: These can be used to help provide an indication of potential profitability of the reporting company, especially when you look at whether these figures have expanded or contracted over time. Margins can also serve as a way to make parallel comparisons between two companies’ profitability when their EPS and net income figures themselves do not present “apples-to-apples” comparisons.
Review the Financial Statements Included In Earnings Press Releases
You can get even more insights into a company’s performance by reading the financial reports that are released with the earnings announcement. These can include an income statement, balance sheet, and statement of cash flows for the most recent fiscal quarter or year.
Income Statement: Typically considered the most important financial report for investors to review during earnings season, the earnings metrics mentioned in this article appear in the income statement.
To give you an idea of how a company’s reporting can look, take a glance at Apple’s income statement from second quarter 2015.4
Balance Sheet: The balance sheet provides a snapshot in time of a company’s assets, liabilities and shareholders’ equity. It is based on the following formula:
Assets = Liabilities + Shareholders’ Equity
Essentially, its purpose is to show what the company owns (assets), how much it owes (liabilities), and how much shareholders own after liabilities are subtracted from assets. Investors often compare a company’s current stock price with the total value of the company’s assets, also known as book value.
Cash Flow Statement: This report summarizes how a company is managing its cash, including inflows and outflows for operations, investments, and financing. Monitoring a company’s cash management is important since even profitable companies can run into liquidity issues.
Make the Most Of Earnings Season
Having learned the fundamentals and benefits of analyzing earnings, you’re in better shape to make smarter decisions during every earnings season.
The content and metrics defined above are provided for informational purposes only. Metrics may contain forward-looking projections which may not achieve intended expectations. Past performance is no guarantee of future results.
1 Radcliffe, Brent, “How to Decode a Company’s Earnings Reports,” Investopedia.com, 2015.
2 Rothbot, Scott, “How to Listen to Earnings Conference Calls,” TheStreet.com, May 1, 2007.
3 “What Is the Difference Between EBIT and EBITDA?” Investtopedia.com, 2015.
4 Apple, “Apple Reports Record Third Quarter Results,” Apple.com, July 21, 2015