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7 Keys to Reviewing an Earnings Report
Traders typically use charts and technical analysis to help them make decisions about when to buy. But fundamental analysis also can provide key insights.
One solid source for fundamental data is a company’s quarterly earnings statement, which provides an in-depth look at the company’s financial information.
“Earnings reports discuss a wide array of financial information that can provide a good indication regarding both the health and the trajectory of a company,” said Brian Bachelier, vice president of active trader strategy at Scottrade. “As a trader, it’s important to become comfortable with the language inside these often-dense reports.”
Here are some key figures you may want to look at when analyzing a company’s earnings. Note that different companies might use slightly different terms for each of these indicators, and the relevance of each number can vary among companies and industries.
- Revenue: Generally located at the top of the income statement (hence why it’s sometimes referred to as “top-line”), revenue for the quarter tells investors how much money the company made in sales. Although revenue seems straightforward, the raw number may not mean much unless you compare it to something else, such as revenue in the same quarter of the last year. It’s important to make apples-to-apples comparisons. For instance, revenue might fall if a company sells off or shuts down a division or product, but profits actually could increase.
- EBIT: Earnings Before Interest and Taxes (EBIT), or operating income, is the company’s revenue minus the cost of goods sold. Basically, EBIT provides a raw indication of the profitability of a company’s day-to-day operations. In addition, EBIT takes into account depreciation (the decrease in value of tangible assets) and amortization (the decrease in value of intangible assets). Like revenue, it’s important to compare the current EBIT with EBIT from the same quarter a year prior to get an accurate gauge of the company’s performance.
- Net Income: Net earnings are EBIT minus the cost of interest payments and taxes. This is often called “the bottom line” since it’s generally located at the bottom of an income statement. Although EBIT can provide a good gauge of profitability, at the end of the day, profits can only be counted after including interest and taxes. And as with many of these numbers, it is best to compare the growth of net income over time to get a better gauge of a company’s financial situation.
- Diluted Earnings per Share: Divide net income by the total number of shares outstanding and you have diluted earnings per share (EPS). When you’re comparing the performance of companies in the same industry, the growth in EPS of each can be more meaningful than the standalone earnings-per-share number. Sometimes, you will see both “basic earnings per share” and “diluted earnings per share.” Diluted earnings per share includes the impact from a company’s convertible stock, convertible bonds, warrants or outstanding options, while basic EPS does not.
- P/E Ratio: Price-to-earnings (P/E) ratio divides the current stock price by a company’s earnings per share. A company’s P/E ratio can be a good indicator of whether that firm is overvalued or undervalued. Companies with a higher P/E ratio are considered “expensive” because you are paying more for each dollar of earnings compared to a company with a lower P/E ratio. However, P/E ratios vary widely among companies, and different industries have P/E ratios that are considered healthy. Therefore, it’s generally recommended to compare P/E ratio with that of other companies in the same industry.
- Cash and Cash Equivalents: On the balance sheet – which is released with earnings – a company reports how much of its assets are in cash or in investments that can be immediately converted into cash. In general, companies with a healthy amount of cash are in a better position to meet existing liabilities than ones where cash is scarce.
- Forecasts: When a company releases its quarterly earnings, it may also provide a forecast for revenue and earnings for the upcoming quarter and, in some cases, fiscal year. This information can be a key barometer of what a company expects in the near future. Traders and investors also should consider reviewing independent forecasts from investment banks and research firms. Scottrade clients can find forecasts from third parties such as Morningstar and Thomson Reuters.
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