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What exactly do quarterly earnings tell us?

By Larissa Fernand
August 24, 2015 11:26 IST
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Each quarter, public listed companies are required to declare their earnings and report their performance. By these disclosures, shareholders and potential investors are made aware of the financial health of the company.

How do analysts, shareholders and potential investors use it?

Quarterly results enable investors compare the company's progress from year to year.

Analysts will look at various metrics such as net income, net sales, earnings per share, earnings from continuing operations and expenses.

The report from the first quarter of the current year gets compared to the report of the first quarter of the previous year to gauge progress.

Analysts can identify areas where the company has experienced issues from one year to the next, and can then monitor whether those issues are addressed prior to the second quarter's report coming out.

It is also useful when compared to consensus earnings estimates. Before an earnings report is announced, analysts release their expectations.

Or, they are polled in advance.

The media takes the average from analysts and releases the 'forecast' numbers to the public. Using that as a base, earnings surprises could be either positive or negative.

Positive earnings surprises occur when actual reported earnings are significantly above the forecasted earnings per share.

Negative earnings surprises occur when reported earnings per share are significantly below the earnings expectations.

Earnings estimates are basically a numerical view of expectations, and changing expectations drive stock prices.

In fact, an earnings surprise can have an immediate impact on the price of a stock.

Stock prices of firms with significant positive earnings surprises show above-average performance, while those with negative surprises have below-average performance.

Stock prices are often extremely sensitive to quarterly earnings results. There can be other factors too that instantly impact the stock price.

Let's look at one of the most famous stocks in the world.

In April 2015, Twitter posted its first quarterly results. The New York Times reported that Twitter posted weaker-than-expected financial results for the first quarter.

Twitter's revenue grew 74 per cent in the quarter, but that was less than the 97 per cent growth seen in the fourth quarter and below the company's own forecasts. The stock ended the day down 18 per cent.

The New York Times reported the company's second quarter results in July 2015. Twitter reported a 61 per cent increase in revenue and a narrower net loss than a year ago.

However, Jack Dorsey's assessment of Twitter's failures overshadowed the company's financial performance, which exceeded Wall Street's expectations. As a result, the stock fell as much as 11 per cent in after-hours trading. (Jack Dorsey is the company's co-founder and interim CEO).

The financial health of a company is measured through its quarterly and annual reports.

The annual report offers a detailed overview of the company's performance from the previous year, and the quarterly budget reports help fill in the details on an ongoing basis by giving a chronological overview of the financial condition.

When used in concert, quarterly and annual reports can be an invaluable way for a shareholder or analyst to monitor the financial health of the company.

The analysts look at other parameters too in a bid to enable them to get a good grasp of the company's financial health and ongoing business conditions.

Is the company's growth slowing down or picking up? If so, compared to what period -- last quarter, last year or last two years?

Is the stock cheaper or more expensive based on the latest analysis of its intrinsic value?

How much did the company's capital structure change?

Is the company sacrificing long-term profitability for the sake of short-term growth?

Quarterly earnings reports have their place. It helps investors keep tabs on how each of stock is doing, and earnings reports can be a signal that it's time to sell your shares.

If the past few quarters have been bad, then the latest earnings report will be a good indication of a continuing negative trend or a reversal of fortune.

However, don't simply sell just because one quarterly result is bad. Dig deeper. Take action only if there is a fundamental problem with the company and its long-term prospects.

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Larissa Fernand