Every quarter, public companies allow investors inside their financials in the form of quarterly earnings. The dance between analysts and the company helps investors learn about the goings inside Google, for example.
A glimpse into the company’s operations and financials helps investors determine many things. For example, we can learn what might impact the company’s future growth or get better insight into a particular project.
As an individual investor, understanding how to read quarterly earnings and what we can glean from the information can help us determine if our thesis remains intact.
The bottom line is that these reports help us better understand the company and management.
In today’s post, we will learn:
- The Importance of Reviewing a Company’s Earnings
- Step-by-Step Guide to Reviewing Earnings
- Walk Through of Each Step
Okay, let’s dive in and learn the eight steps to reviewing a company’s earnings.
The Importance of Reviewing a Company’s Earnings
Understanding a company’s quarterly earnings is essential for investors, analysts, and consumers.
These earnings provide a snapshot of a company’s financial health and performance over three months, offering valuable insights into its overall stability and growth potential.
A note about the timing of earnings: In the US, companies have an SEC requirement to post earnings every quarter (or three months). But, in Europe or the rest of the world, they don’t have the same requirement. For example, a company I own, Adyen, only reports every six months.
Also, not every company does an earnings call. It is not a requirement and remains completely at the discretion of management. For example, Warren Buffett at Berkshire Hathaway doesn’t provide quarterly commentary beyond his required 10-Q filing.
He prefers to avoid the temptation or influence of Wall Street on his company’s stock price; he would rather the financial results speak for themselves.
Firstly, quarterly earnings reports allow investors to make informed decisions about buying or selling a company’s stock.
Positive earnings indicate that a company generates profits, which could increase stock prices. On the other hand, negative earnings might suggest financial troubles, prompting investors to reevaluate their investment strategies.
By studying these reports, investors can adjust their portfolios accordingly, aiming for the best possible returns.
Secondly, understanding quarterly earnings aids analysts in assessing a company’s management efficiency and business strategies.
By comparing current earnings to past quarters and industry benchmarks, analysts can gauge whether a company is on track to meet its financial goals. Understanding the results helps them make recommendations to investors, influencing the stock market and the company’s reputation.
Consumers also benefit from comprehending quarterly earnings as it can impact their purchasing decisions.
Companies with positive earnings are more likely to invest in research and development, leading to improved products and services. Conversely, companies struggling with earnings might reduce innovations, potentially affecting product quality or customer service.
In summary, grasping a company’s quarterly earnings is crucial for multiple reasons.
Investors rely on this information to make wise investment choices, analysts use it to evaluate a company’s strategies, and consumers can gauge its overall health and ability to deliver quality products or services.
By understanding quarterly earnings, individuals can navigate the complex world of finance more effectively and make informed decisions that align with their financial goals and interests.
Step-by-Step Guide to Reviewing Earnings
The best way to work through a company’s quarterly earnings is to use a checklist.
Using a checklist allows you to remain consistent; it also helps you keep track of how well your company remains on track. Another good habit is to create an earnings journal so you have a place to keep track of your thoughts.
I use Journalytic, a free resource, but I have seen many people use Excel, Word, Google Sheets, or Docs.
The medium isn’t important; keeping track and writing down your thoughts remains far more important.
Here is the checklist I use to work through each earnings call.
- Gathering earnings reports
- Analyzing revenue performance
- Analyzing profits using metrics
- Examining EPS (Earnings per share) performance
- Investigating Free Cash Flow (FCF)
- Understand forward guidance
- Analyze management commentary
- Consider qualitative factors
We use the above framework to help us ask and answer questions.
For example, is the company’s revenue growing, and by how much? Is this normal for them, or is it a result of some new product, service, or a one-time event?
All these questions go to the central idea, is the thesis still intact, and is Google executing as expected?
Walk Through of Each Step
Okay, let’s walk through the above checklist using my company, Texas Instruments (TXN). We can walk through each checklist item and discuss how to interpret the results.
Remember, this is my process, and you can adjust to meet your needs. Use this as a framework to adapt.
Step 1: Gathering Earnings Reports
We have many different options when it comes to accessing earnings reports. The four most important to reference are:
- 10-Q or official filing (if available; not every company will offer this immediately)
- Press release
- Transcript of an earnings call
- Earnings slides
These reports allow us to gather all the necessary information. And the best part, they are all free and accessible.
The best information sources generally come from the company itself, but sometimes the company doesn’t have the best tech.
Here are some of the resources I like to use:
- Company Investor Relations
- Quartr App
- Seeking Alpha
I like to use the company Investor Relations tab to find the official filings (10-Q or 8-K). Here we can find almost everything we need, and it is a free resource.
Listening to the call while reading it is also a great way to capture a ton of information, and the Quartr app remains the best. It is a free app that allows you to access all the company’s quarterly calls, transcripts, and earnings slides.
Some companies will offer audio recordings via their website, but often they are limited in time to the last year. So, if you want to listen to several years of calls, you might not have access.
Bamsec is another great resource for reading all the required company financials, i.e., 10-K, 10-Q, earnings call, and 8-K (press release).
The financial websites offer many of these services as well.
So, in the case of analyzing Texas Instruments’ latest earnings call. I would go to their company website and pull up the Investor Relations page and find the following documents:
- Earnings release
- MP3 Audio
These four documents provide all the information I need to analyze Texas Instruments’ latest quarter.
Step 2: Analyzing revenue performance
We can analyze the company’s revenue performance using a combination of the press release and transcript.
Texas Instruments did $4.53 billion in revenue for the quarter, an improvement of 3% from the prior quarter but down 13% from the similar quarter last year.
We also want to look at longer-term trends, say five years and the last eight quarters, to determine a trend in revenue, either up or down.
Using Stratosphere, we can see the company saw revenue growth until this current year. In the past twelve months, Texas Instruments has seen a drop of 3.9% in revenue. And looking out over the past eight quarters, we see constant growth until the last three quarters.
We will want to investigate the drop in revenue using the earnings call transcript. We do this to determine if management understands why revenues continue to slow.
We will touch on this in the qualitative section.
Step 3: Analyzing profits using metrics
We can use the company financials from the press release or 10-Q to calculate the ratios ourselves. Or, to save time, we can use a financial website like Stratosphere.
Using Stratosphere, we see:
- Gross margins = 66.3%, down year over year
- Operating margins = 45.7%, down year over year
- Net margin = 40.8%, down year over year
- Free cash flow margin = 9%, down year over year
Across the board, Texas Instruments continues to see downward pressure on margins. Zooming in to look quarterly, we see the same downward movement.
Again, something to note and look for explanations from the earnings transcript and, if available, the quarterly filing.
Step 4: Examining EPS (Earnings per share) performance
Using the press release, we can see the company saw a decline of 24% in EPS in the quarter, and using Stratosphere, we see that over the past four quarters, the company has seen a steady decline in EPS.
Again, not surprising, given the decline in revenues and margins, and another item we want to get to the bottom of by finding out what management has to say.
One thing to note related to EPS…
Texas Instruments is a heavy buyer of its shares, which can sometimes mask a downturn in net income. When analyzing a company that is a heavy buyer of its shares, you should always look at the raw net income number to double check.
If you see EPS going up or staying flat, but the net income line is falling or steady, the company is not growing earnings; it is only reducing its share count.
While in the short term, it is fine, this trend is something to watch in the coming quarters.
By the way, not the situation with Texas Instruments, but something to know.
Step 5: Investigating Free Cash Flow
Returning to the press release and company financials, we see after multiple years of free cash flow growth, the company has seen a fall this year.
Cash flow from operations fell 15%, Capex (capital expenditures) rose 49%, and free cash flow fell 46% in the quarter. To further cement the fall, free cash flow as a percentage of revenue fell from 30.1% to 16.9% in the quarter.
Free cash flow is one of the most important metrics to track because it dictates how well a company can reinvest to grow or what other capital decisions it might have to make.
Texas Instruments focuses heavily on free cash flow. It is a part of its culture and something they comment on regularly in any communication. You could say it’s part of their DNA.
Add free cash flow to the growing list of items to investigate.
Step 6: Understand Forward guidance
Depending on the company, some will list any guidance in the press release, some will announce it in the earnings call, while others might not give any, i.e., Berkshire Hathaway.
Forward guidance informs analysts and investors about what the company expects to produce shortly.
They might announce guidance on revenue, earnings, margins, free cash flow, or acquisition targets.
Much of it will depend on the company and how much they want to announce. It is part of the dance with Wall Street and analysts. Many companies announcing guidance will often “low-ball” estimates to constantly outperform their expectations.
By doing this, they can game the system because analysts and Wall Street react positively or negatively to beating estimates.
Texas Instruments provides next quarter guidance in the press release.
They state they believe they will produce revenue in the range of $4.36 billion to $4.74 billion and EPS in the range of $1.68 to $1.92.
If they produce these numbers, they will see another down quarter in revenue and EPS.
Step 7: Analyze management commentary
Using the earnings transcript, we can analyze what management believes will happen to the company in the coming quarter plus the full year.
Often they will outline their plans and what they expect to happen with any projects or acquisitions they have made. They will also discuss future plans, what they see in the market, and how competition might impact their results.
The more honest companies will discuss where they think they might not be meeting expectations or why they believe the company underperforms.
The earnings transcript has two parts. The first part is a pre-recorded commentary from management, often the CEO and CFO, but sometimes they have others on the call.
The second part consists of analysts asking questions of management. In theory, this should be where analysts grill management, but analysts have to walk a fine line between discovering information relevant to the company and not pissing off management too much or risk losing access.
Most of the time, analysts will ask softball-type questions in a manner of trying to extract information without offending management. It is a bit of dance.
Sometimes you might not get direct answers, but you can learn a lot from the focus of analyst questions and the items management is willing to discuss.
The earnings call remains a perfect place to find answers to any questions. Sometimes they might not address any concerns in the management commentary. You might have to sort through the analyst question section.
The best way to do this is to use the CTRL-F function to search for topics such as revenue.
Step 8: Consider qualitative factors
After working through the information presented in the earnings calls, slides, press releases, and company financials, we should have a good sense of how the company performed.
We can then assess how Texas Instruments did relative to others in the industry.
For example, we can do this by looking through the financials using Stratosphere. You can also listen to earnings calls from competitors to get a sense of the industry. And for big-picture ideas, you can look at the market sentiment or status of the economy.
Remember, the numbers tell us a story; our job is to figure out what the story tells us.
For example, Texas Instruments continues to see pressure on revenues, margins, free cash flow, and earnings. At first blush, you might think the company is in trouble, and if you look at the stock price, you might agree.
But after listening to several earnings calls, you could learn that these are all situations the company has talked about for a while now.
They are in the process of building another fab factory to expand their capacity. And to do this, they will spend billions of cash to build the factory. These capital expenditures will pressure free cash flow for a few years.
The company also expected revenues to slow as product demand slowed. In an earnings call, Texas Instruments told investors this would happen over a year ago. As for margins, the company has many fixed costs, meaning margins will come under pressure when revenues fall.
We can easily answer all the questions from above as we work through the earnings releases.
Bottom line: Texas Instruments’ investment thesis remains intact, despite the fall in share price.
Earnings calls play a pivotal role for investors as they provide a comprehensive and timely insight into a company’s financial performance and strategic direction.
These calls, typically held quarterly, allow investors to gauge the company’s health, growth trajectory, and profitability.
By analyzing key metrics such as revenue, earnings, and guidance, investors can make informed decisions about buying, selling, or holding stocks.
Earnings calls also offer a unique opportunity to hear directly from company executives, including CEOs and CFOs, as they discuss their perspectives on market trends, competitive landscape, and potential challenges. This information aids investors in understanding management’s strategies, risks, and operational efficiency.
Furthermore, earnings calls facilitate transparency and accountability, enabling investors to assess if a company is meeting its targets and aligning with its long-term goals.
Overall, these calls empower investors to make prudent investment choices, manage risk effectively, and adapt their portfolios in response to changing market dynamics.
And with that, we will wrap up our discussion on reviewing a company’s earnings.
Thank you for reading, and I hope you found something of value. If I can further assist, please don’t hesitate to reach out.
Until next time, take care and be safe out there,