Earnings Report Overview
Do you have a stock portfolio? If so, you’ll want to pay attention to quarterly earnings reports. Every three months, publicly traded companies are required to release a report detailing their financial performance from the previous quarter.
These reports can be confusing for those who don’t have a background in finance, but they can also be a goldmine of information for people looking to trade or invest in stocks.
In this blog post, we’ll discuss what quarterly earnings reports are, how to read and interpret them, and what effect they have on the stock market.
We’ll also provide some trading strategies that you can use when quarterly earnings reports are released. So, by the end of this post, you’ll have a better understanding of how to use earnings reports to your advantage as an investor.
So, what is an Earnings Report?
So what is an earnings report? In short, it’s a quarterly report that publicly traded companies are required to release, detailing their financial performance. The report includes information on revenue, expenses, profit, and much more. Earnings reports are released either before the market opens, or after the market closes on a specified date.
These documents give investors insight into a company’s financial health. By looking at a company’s revenue, expenses, and profits, investors can get a better idea of whether or not the company is doing well and if its shares are worth buying or selling.
Furthermore, analysts and investors often use an earnings report as a way to gauge a company’s performance and make predictions about its future prospects.
Earnings Per Share & Revenue
For investors and traders, the two most important data points found in its financial earnings reports are the Earnings Per Share (EPS) and Revenue (Sales) metrics.
Companies who beat and raise EPS & Sales expectations over multiple quarters will outperform the market by a wide margin.
Income Statements, Balance Sheets, and Cash Flows
There are three main sections of an earnings report: income statement, balance sheet, and cash flow statement.
The income statement shows a company’s revenue and expenses for the quarter. It also includes the company’s net income (or profit) for the quarter. The net income is calculated by subtracting total costs from revenue.
The balance sheet shows the health of a company’s assets and liabilities at the end of the quarter. Assets are things that a company owns (such as cash or property) while liabilities are money that a company owes (such as money owed to creditors). The balance sheet also includes shareholders’ equity, which is equal to assets minus liabilities.
Cash Flow Statements
The cash flow statement shows how much cash a company has generated (or lost) from its operations over the quarter. The cash flow statement is divided into three sections: operating activities, investing activities, and financing activities.
Operating activities include things like sales and the payment of expenses. Investing activities include things like buying or selling property or equipment. Financing activities include things like issuing new shares of stock or borrowing money from lenders.
Using EPS Reports to Make Better Investment Decisions
Trading decisions are often made based on the information contained in these reports. Therefore, during earnings season (the period when most companies release their earnings reports), stock prices can be volatile as investors react to the news. Some investors try to capitalize on this volatility by trading around earnings announcements.
Typically, if a company’s earnings report exceeds expectations, its stock price will rise. And in some cases, an earnings report can spark a huge gap and begin a massive run-up in price. Below you can find examples of recent companies whose earnings reports beat expectations and went on to be major winners in the market.
In the example above, Lending Corp gapped up after an earnings report and went from $20 to $40+ in a matter of only a couple of months. This is a great illustration of how a company can make a massive run after a positive financial report.
Conversely, if a company’s earnings report falls short of expectations, its stock price will drop. This can be a scary time for investors and traders alike, as large institutions unload shares in a massive way causing a large gap down in price. Below are examples of this action on a chart.
In the example above, you can see how Fastly Inc. had multiple gap up and gap downs. The initial gap up in May of 2020 set the move in motion, but subsequent gap downs in August and October of 2020 put an end to its run.
Managing Risk During Earnings Season
Learning how to analyze financial statements is not enough to manage your portfolio of stocks during earnings season.
To adequately manage your risk, you must ensure that any company you hold going into earnings is properly sized and has enough cushion to withstand a poor report, which runs the risk of a major gap down in price.
3 Step Guide to Managing Risk
- Always check the calendar and know when each company in your portfolio reports its quarterly or annual earnings report. Deepvue shows you when a company is reporting soon so you are always aware and prepared.
- Make sure you have a sizeable cushion on your position (at least 1-2x the implied move).
- Ensure that your investment doesn’t exceed more than 15-20% of your entire portfolio. Proper position sizing is one of the best ways to manage risk.
EPS and Revenue (Sales) data are the most important – but you can find much more about a company through these quarterly or annual reports.
You can also learn from an example of a recent company whose earnings report beat expectations and went on to be a major winner in the market, as well as an example of a company that had a negative financial report and saw its stock prices drop significantly.
Always remember, it’s the reaction to the news that’s important, not the news itself. Managing your risk during earnings season is critical for anyone to be successful in the stock market. Learning how to analyze financial statements as well as taking the appropriate position sizing measures will help you better manage your portfolio.
Frequently Asked Questions (FAQs)
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