Previously, I wrote an article on reading a stock chart. But something that was missing was the “prequel” to that article. It’s great if you can understand how to analyze stocks, but the first step is to better understand the company you’re analyzing. You might be wasting a ton of time researching and analyzing the stock if the company isn’t one you should even be investing in.
That’s why in this article, I’m going to teach you how to read a company earnings report. I’ll cover what an earnings report is and why it’s important, what’s included in one, where to find them, and what you should be looking at when you finally review an earnings report.
Let’s get started.
What is an earnings report?
A company earnings report is a document that publicly-traded companies are legally required to produce every quarter (called a 10-Q) and annually (called a 10-K). This document outlines the financial position of the company, as well as any other relevant information the company wants to or has to, share (more on this below).
While publicly traded companies are required to produce these documents by the SEC, many of them want to, since it’s an opportunity for them to share the current state of their business. In many cases, companies can use it as a “sales pitch” to current and potential investors.
And as an investor, you can use the company earnings report to decipher whether or not the company is worth investing in, based on things like management, their financials, any legal issues, market trends, and much more.
In short, the earnings report is an excellent way for you as an investor to gain insight into a company – but it takes patience and know-how to make the most of these reports.
What’s included in a 10-Q?
For the sake of this article, I am going to focus on the 10-Q – which is the quarterly summary companies have to produce since it’s more timely information. Here’s a snapshot of Apple’s most recent 10-Q, from May 2020:
Note: the annual report (10-K) is usually very lengthy, filled with highlights, photos, and a bunch of stuff you either don’t need or that will be irrelevant by the time you’re reading it. I’m not saying a 10-K isn’t valuable, but I prefer to utilize a 10-Q because it’s fresher information and less time is spent on making it look fancy.
So what exactly is included in a 10-Q that makes it so valuable? Well, there are two parts: financial information and other information. The financial information is the bread and butter of the 10-Q, but you can certainly pull value from the other information, too.
Financial information includes the actual financial statements, as well as sections like the Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A), Quantitative and Qualitative Disclosures of Market Risk, and Controls and Procedures. Here’s what Apple has in their Part 1 from the most recent 10-Q:
Other information, on the other hand, contains things such as Legal Proceedings, Risk Factors, and Other Information and Exhibits. Apple has these, as well as a few other sections in their 10-Q.
Below, I’ll break the important ones down a bit further.
While the entire part is sometimes called “Financial Statements” there are other pieces within it. But as I mentioned, the most important part is the actual financial statements, which can be quite long. I’ll go into more detail below on what you should be looking for (most investors don’t need to know and dissect EVERYTHING on these statements).
In short, though, these are the required statements that show the company’s revenues, expenses, assets, liabilities, etc. Here’s a quick look at the first page of Apple’s financial statements:
Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)
The Management’s Discussion and Analysis of Financial Condition and Results of Operations (usually referred to as just MD&A) is a section that allows the company’s management to discuss the company’s performance overall.
In Apple’s most recent MD&A for example, they discuss the impact of COVID-19, business seasonality, how different products and segments have performed, and more.
Quantitative and Qualitative Disclosures About Market Risk
This section is required for companies to provide any quantitative and qualitative disclosures about market risk. According to the SEC,
“On January 28, 1997, the Commission adopted new rules that require disclosures about the policies used to account for derivatives, and certain quantitative and qualitative information about market risk exposures.”
In this section, the company will outline any existing legal action being taken by or against them. The SEC states that a…
“legal proceeding need only be reported in the 10-Q filed for the quarter in which it first became a reportable event and in subsequent quarters in which there have been material developments.”
I really like the risk factors section, though sometimes the information is common sense. This is where the company can explain factors that are impacting their business negatively – so you can get a sense of what is top of mind for them and if they’re really recognizing market risks. Apple, for instance, talked about being impacted by COVID-19.
What is earnings season?
Earnings season is a phrase for when companies begin to report their quarterly (or annual) earnings. For quarterly reports, companies tend to do this in the weeks following the close of a quarter. So, you’ll have “earnings season” four times a year – usually in early April (to recap the first quarter), early July (second quarter), early October (third quarter), and early January (fourth quarter).
Depending on the size of the company, an organization has to file its 10-Q between 40 and 45 days after the close of the fiscal quarter. Apple, for instance, filed its first-quarter 10-Q on May 1 – about 30 days after the close of the quarter.
Where do you get an earnings report?
The best way to get an earnings report is through the SEC directly. They have a system called EDGAR, which allows you to search for any publicly-traded company and find their earnings reports (among other related documents).
In addition to EDGAR, you can use the NASDAQ Earnings Calendar, which is much more visually appealing and allows you to save companies to your watch list, as well as see a list of upcoming events – such as earnings reports that are due to come out.
Most companies also put their earnings reports on their website. An easy way to find this is by searching “[Company name] + earnings report” in Google.
How do you best read a company’s earnings report?
Now for the meat of the article – how to read a company’s earnings report. They can get long, complex, and (quite frankly) super boring. (I spent the early years of my career pouring over earnings reports and listening to earnings calls, so I feel like I’m allowed to say that.)
With a 10-K, you’ll tend to see things like press releases and fancy booklets to talk about the previous year in as positive a light as possible. That’s why I love the 10-Q – it cuts through the fluff and gets right to the point. You won’t often see things like a press release on a 10-Q (though they can be lengthy – upwards of 100 pages or more at times).
Apple jumps right into their financials on page three after a header page that bleeds over into the second page. No fluff.
You’ll want to spend most of your time on the financials. This is going to tell you how the company performed in the last quarter (and how that performance compared to the quarter before it, or the same quarter in prior years), if revenues have improved or gone down, and how expensive it is to bring in new business (the cost of sales), to name just a few things.
Okay, here’s what I look at:
The income statement
The income statement basically tells you how much money that company has made in a certain period of time. On the 10-Q, this is almost always the current quarter’s income (compared to previous quarters). Here’s a look at Apple’s:
Note that total comprehensive income is their income after all adjustments have been made (on this sheet).
Total revenue (or total sales)
Total revenue is how much the company did in sales during that period of time (or quarter, if you’re looking at the 10-Q). It’s definitely not the best indicator of company success, though, because it doesn’t account for the cost of getting those sales (rent, logistics, people, etc.).
However, it does give you a quick snapshot of how the company is trending in terms of their sales over a given period of time – which is a very helpful birds-eye view of performance. For example, you can see this quarter’s sales at Apple were nearly identical to the same quarter’s sales in 2019:
You can look at this one of three ways. Either a) sales have been flat over the course of the year and they’re not generating enough new business, b) the cost of making those sales have gone up or c) there have been unforeseen market risks which caused sales to flatten, yet they’re still staying competitive.
When you look at the cost of sales and operating expenses (more on these below), things haven’t changed TOO much. But didn’t we have a pandemic in early 2020? Oh yes, that’s right.
So you might say that Apple slightly increased its sales compared to this quarter last year, but they did that all while dealing with a pandemic. And for Apple specifically, that meant closing all of their stores, among other adjustments.
See how this can be fun and more valuable than just taking someone’s blind recommendation?
Cost of sales
The cost of sales outlines how much it costs to produce the goods that are sold. So if Apple ONLY sold computers, this would be the cost to manufacture, package, etc. those computers to be ready for sale.
Again, this isn’t a great one-stop-shop for analyzing company performance, but it will quickly tell you if raw materials used to produce the goods sold are getting more expensive.
Under the cost of sales still, you’ll see a single line item that shows you the gross margin. Simply put, this is the total net sales minus the cost of those sales. The gross margin doesn’t include all other expenses and is not a true picture of the company’s actual margin, but again, it’s a great high-level data point to understand how wide their margins are. If gross margins are shrinking, that may be cause for concern.
Operating expenses aren’t necessarily the most important, but I always look at it just for another piece of data. This includes other costs, such as research and development, marketing, etc. that add to the overall cost of running the business. It ultimately reduces margins, but it can be extremely difficult to determine the story behind the numbers by just looking at it.
For example, Apple’s operating expenses have gone up quite a bit compared to the same quarter last year. But am I concerned? Not at all. Take a look:
The fact that more money is being spent on research and development is a good thing. I don’t necessarily assume it costs more to do this work, but you might make the assumption they’re putting more money into testing new technology – which may accelerate future earnings growth.
This is a big one. Net income is considered the “bottom line” since it’s literally at the bottom line of the cash flow statement. But net income is an excellent metric to look at for quickly assessing a company. It tells you how much the company made after all costs of running the business have been taken out.
It’s REALLY important to note that a company whose net income is negative isn’t ALWAYS a bad thing. Some businesses take years to turn a profit, and that’s okay because they’re building a base for a stronger future. For instance, here’s a snapshot from Uber’s first-quarter 10-Q this year:
You can see they’re operating on a net loss, and that deficit has increased compared to the same quarter in 2019. This in and of itself doesn’t make Uber a bad investment, though. There are plenty of other factors to consider.
To broaden your research, you can use a broker that gives you the tools you need, all in one place. One great option right now is Public – they give you a ton of research tools to help you buy stocks with more confidence, such as powerful advanced charts and multiple technical indicators.
Earnings per share (EPS)
Probably many people’s favorite data point is EPS – or Earnings Per Share. This number takes the company’s net income and divides it by the number of outstanding shares that exist. Basically, it’s a snapshot of what would happen if the company took their net income and spread it evenly across every single share.
Now obviously, that’s not what really happens (more on this in a minute). But it’s a great way for you to compare how a company is doing on a more objective basis. Net income by itself is good, but what if the company has grown exponentially and more (or even less) shares are now outstanding? This gives you a “denominator’ to help explain the earnings with a bit more context – hence why this is such a talked-about metric.
Going back to my point above, companies don’t always give earnings back to their shareholders. When they do, it’s called a dividend (by the way, if you don’t already know, I am a huge dividend fan – and it’s a core tenant to value investing).
But some companies take those earnings and reinvest them into the company. A lot of younger, growth-oriented companies skip paying a dividend and instead put their money back into the business. Again, not a bad sign at all, but a data point to consider.
How EPS impacts the market
You’ll hear a lot about whether companies “beat” or “missed” earnings, especially during earnings season. Analysts predict how earnings per share will come back for most companies. If a company exceeds that target, it’s usually a good thing. If they miss, it’s not necessarily bad, but you should expect to see some explanation from the company.
Beating and missing EPS targets almost always cause stock prices to move. But it really shouldn’t because it’s not a true indicator of how the company is performing as a company. The business can still be incredibly profitable but may have missed the earnings estimate for some unforeseen reason.
There are a lot of risks in just using one piece of data to buy a stock, so like everything else, use EPS and the movement of a stock after it’s announced as just a single data point in your overall analysis. For instance, one of the things I like about E*TRADE is that they give you access to a broad set of tools and resources to do an in-depth analysis of stocks. This way you can make a far more informed buying decision.
Statement of Shareholder Equity
The SEC explains shareholders’ equity best in saying it’s…
“sometimes called capital or net worth. It’s the money that would be left if a company sold all of its assets and paid off all of its liabilities. This leftover money belongs to the shareholders, or the owners, of the company.”
The Statement of Shareholder Equity can be very valuable sometimes, but other times it’s worthless to me. It really depends on the stage the company is in. If they’re experiencing a rough time or a huge growth time, I am very interested. Otherwise, I glance at it and move on.
Free cash flow
It’s good to look at how much free cash a company generated in the most recent quarter. You do need to calculate this manually, though. Different firms will calculate this differently, but the most common way is to subtract capital expenditures from operating cash flow:
Operating cash flow − capital expenditures = free cash flow
Most people will gravitate to EBITDA (earnings before interest, taxes, depreciation, and amortization) but free cash flow is actually a better indicator of performance in my opinion.
You typically want to see a company generating positive (and even better – increasing) free cash during a set period of time, unless there’s a really good explanation for why they aren’t. Note that you won’t always find this data on a 10-Q, so you may have to dig a bit.
Other things to look for
I always look at the legal proceedings in case there are any scandals out there worth noting, as well as the risk factors – which outline some important things from the company’s perspective (like COVID-19, in Apple’s case).
I usually don’t care for the company’s commentary, since it’s their own report and I feel like it will always be slightly favorable to them – which is why I like to stick to the data and review the financials most.
This should give you a fairly good starting point for finding and understanding what to look for in a company’s earnings report. The 10-K isn’t much different from the 10-Q – it’s just longer, fancier, and has more data in it from a longer period of time, so all of this information will easily transfer over to you reading annual reports.
You now should have an idea on how to understand earnings, then take that information and analyze how to read a stock chart to begin making a far more intelligent investment decision.