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How to Understand a Company’s Financial Results
Thinking of a company’s financial results in terms of a checkup on its health can help determine whether or not it’s a fit for your portfolio.
Whether you are considering buying stock, already own some or you just want to better understand how the public company you work for is performing, take a look at a company’s quarterly financial results.
“Observing and analyzing a company’s financial results over several quarters can give even a novice a good idea of a company’s financial health,” said Marsella Martino, a senior investment strategist at PNC.
But if you don’t quite know what you’re looking at, those results can be intimidating and confusing.
What are Financial Results?
Just like routine doctor visits, most companies have financial “checkups” each quarter, shared with the public as their earnings report.
One common measure of a company’s health is its profit, also known in financial terms as total earnings or net income. It can be referred to as the “bottom line” because it appears at the bottom of the income statement.
“Earnings are a tool to value what a company is worth, and if their growth can support higher stock prices over time,” said Martino.
Earnings can demonstrate the financial capability of a company – their ability to continue to grow.
Looking at its earnings per share (EPS) over time is one common method used by Wall Street analysts and everyday investors alike. Investors often look at earnings on a per share basis because it reflects profit in proportion to an investor’s ownership stake. Earnings growth can lead to higher share prices over time.
Once a company announces its earnings, a conference call often is held for shareholders and analysts. Typically on these earnings calls, executives will explain to shareholders and analysts how the company is performing against its goals in the current environment. This is useful not only to understand the company, but the greater market as well.
Sometimes there are one-time events that could impact results positively or negatively, which may not accurately reflect the company’s health. Often fast-growing companies will reinvest their earnings back into the company to fuel growth, for example.
There also could be an anomaly in the industry or for the company itself. For example, restructuring costs, which are not expected to reoccur yet, are impacting the current quarter’s bottom line.
“Be mindful that events may not reoccur, but the good news is most companies will alert you to these one-time factors,” said Martino. “Reoccurring earnings trends give a better picture of what will happen with the company over time.”
But profitability is not the only measure that people should use to understand a company’s financial health, just like you don’t judge your overall health solely on your blood pressure reading.
“Beyond earnings, look at how the company is operating itself,” said Martino.
Are sales growing? How are they handling expenses? How does management view the forward outlook?
While earnings and EPS are helpful measures, they also can be fraught with pitfalls because companies have some discretion over what’s included and what’s not, which may not give the best company-to-company comparison.
Understand Wall Street Lingo
Much like your health is evaluated by a physician, companies are evaluated by an investment community of professional financial analysts, many of whom work for Wall Street firms. Often they’re simply referred to as “The Street.”
Part of an analyst’s job is to evaluate and attempt to predict how a company might perform over time.
“Companies disclose their financials publicly so individual investors have access to the same information as the public,” said Martino. “Analysts use this information to assess the current quarter’s performance, forecast future earnings, and also to compare the results with peer companies in the same sector.”
And just as you project the realistic progress you expect to make on that diet or exercise regimen, sometimes company management makes public disclosures about their expectations or outlook for future performance, called guidance.
“While most companies try to provide accurate estimates to analysts, there are a lot of assumptions that go into that guidance,” said Martino. “Interest rate moves and other macroeconomic and environmental factors are among unforeseen circumstances that happen outside of a company’s control and can affect guidance.”
The predicted results from the analysts regarding a particular company are referred to as earnings estimates. Meant to be a check-and-balance system, these are independent of a company’s guidance.
Taken together and averaged, these expectations make up what is called consensus estimates or street expectations.
When the media reports on a company’s earnings, they often use the terms “beat” or “missed” expectations. There are three main ways a company is assessed:
- Beating expectations: Also known as delivering a positive surprise, which means it reported stronger than expected financial results.
- Meeting expectations or delivering in-line results means the company performed as expected.
- Missing expectations indicates a company did not do as well as analysts anticipated, or perhaps even missed its own suggested guidance.
“Estimates are beneficial because they give the market and analysts direction on how to value a company and try to forecast a forward outlook,” said Martino.
The market also trades on those estimates, so if a company meets, beats or misses them, shares of the company’s stock could trade higher or lower. For example, if a company misses earnings forecasts, the stock could trade lower on the news.
Where to Find Earnings Results
Although earnings are reported on many financial websites and online resources, companies always will release the report on their website.
“Reading a company’s earnings press release can indicate how they performed as well as a comparison of previous quarters,” said Martino.
Martino further suggests reading a company’s CEO letter in their annual report to become familiar with a company’s operations and strategy.
Diversification is Key
No matter the health of one specific company, diversification of a portfolio is important.
“We always like to look at the broader picture,” said Martino. “While individual stock earnings are important, they all feed into the greater market, which is why we recommend a diverse portfolio across different asset classes and equities across a wide variety of stocks.”
PNC publishes earnings updates for the S&P 500® as a whole. This shows how the market is being valued, which is useful to anyone who’s investing in stocks or looking to invest in a company.
Visit PNC’s Investment Corner for more commentary on the markets and investment insights. »
Many factors contribute to a company beating or missing estimates, including:
- Higher revenue than projected
- Lower expenses than projected
- Higher sales
- Foreign exchange, for international companies
- Supply costs
- Demand of products
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