Editor's note: This was published at the start of Q1 2016 earnings season, but the tips below still apply to all earnings, at any time.
After the closing bell today, America’s largest aluminum company, Alcoa (AA), will report earnings. Even casual observers and those new to the market are probably aware of that, as Alcoa’s earnings are keenly anticipated and said to mark the beginning of “earnings season.” Many of those same people, however, will be unsure of what earnings season actually is, and many more will have no idea of how to assess the report when it comes, or what the various terms used in it actually mean.
There is a theory that the use of jargon and acronyms in situations like this is not an accident. Speaking in a language that outsiders can’t understand keeps the power in the hands of the industry insiders. It makes your financial advisor and others in the know sound smart and therefore to some extent justifies the fees they charge you. Maybe that is a little cynical, but even so investors should understand the decisions made regarding their money, and in order to do so must understand some of the terms used in assessing corporate earnings and the implications of earnings reports for stock prices.
At this time of year, then, a brief explanation of these things seemed like a good idea.
Earnings Report: Every three months, all public companies are required to complete a form 10Q, which reveals that period’s revenue, expenses and profit among other financial details, and file it with the regulatory body the Securities Exchange Commission (SEC). They must publish the details of that report so that shareholders are aware of the company’s performance.
Earnings Season: Most companies divide the year up into calendar quarters ending in March, June, September and December and therefore file and report on their 10Qs a few weeks after each quarter ends, in January, April, July and October. Earnings season is when the majority of companies report and lasts from about a week and a half after the quarter ends until the end of that month. At peak times around 100 firms report each day.
Revenue, Sales or Top Line: The amount of money brought in by the company (total sales) for the quarter. When there are concerns about the general health of the economy, revenue is watched even more closely than profit as weakness from a few early reporting companies may have implications for those yet to disclose their numbers.
Earning, Profits or Bottom Line: The amount of money made by the company in the preceding three months. Obviously, this is the number that most concerns shareholders and potential investors.
EPS: Most of the time, financial media will report a company’s earnings in terms of EPS, short for earnings per share. This is a much better measure for investors than just profits. Companies buy back shares and occasionally issue more and it is the amount of profit attributable to each share that determines the underlying value of a stock.
Estimates, Beat and Miss: Wall Street firms employ analysts whose job is to predict the future. They produce estimates for both revenue and EPS for major companies and as those estimates are public knowledge, they are usually priced into the stock. If the actual results exceed (beat) the average of those estimates it will, absent any other factors, push the stock up. If those results are worse than the average of the estimates (a miss), however, then stock in the company concerned will lose value.
Guidance: Although not required to do so, most companies will, along with their report of what happened in the previous quarter, issue an estimate of what they expect in the next quarter and even over the next year. This is known as “guidance” and will often have more effect on the stock than what has actually happened. If you see a company report better than expected revenue and profit, but the stock drops immediately after the release, then it is usually because the report also contains guidance that is lower than was expected. In that case what happened last quarter is pretty irrelevant; it is the prospects for the future that count.
Whisper Number: The other thing that can cause an unexpected reaction to an earnings report is if traders are expecting something other than the consensus estimate. If rumors abound that a company has done much better or worse than expected, then traders will make their own guess as to what profits will be. That guess differs from the consensus numbers and is known as a whisper number.
For those new to following financial news, the next few weeks will be a confusing enough time as it is. There will be a plethora of reports from companies to digest. Hopefully this quick guide to some of the terms that will be used in analyzing those reports will reduce the confusion somewhat.