11 things you should know about earnings season
As the earnings season is set to start again soon, investors and analysts are gearing up for the numbers and information that will be thrown their way by big corporates. All the companies listed on stock exchanges will soon start announcing their quarterly earnings report as mandated by the Securities and Exchange Board of India (SEBI). What does that mean for you though? How will it affect the way you think?
An earnings report is a document containing information on the company’s financial performance during a quarter and provides details regarding the firm’s revenue, profit, expenses etc.
As an investor, it is important for you to know about the company you have invested in and review its financial performance to see that your investment grows over time.
These reports are not the easiest to read always. This is why we are stepping in with a quick guide on the 11 key components of an earnings report and what they mean:
1) Revenue/Gross sales
Revenue or gross sales, which is also called the topline of the company because it makes the first line of the company’s balance sheet, is the total amount of sales done by the company during a quarter. All the income that a company generates from the sale of goods and other services comes under the gross revenue.
A consistent increase in the top line quarter over quarter indicates strong growth in business. However, it cannot alone be the best indicator of a company’s financial performance as it does not account for the cost of getting those sales or the quality of those sales.
Net sales are the sum of a company’s gross sales minus its discounts, returns and allowances. For instance, a company selling appliances can witness returns by customers due to various reasons such as quality issues with the product. This is taken into account while calculating net sales. It is also considered a better indicator of business health than gross sales for this reason.
Operating expenses mainly include the cost of doing the business. It would include manufacturing/service cost, marketing expenses, salaries, advertising, insurance, research and development, rent etc.
Higher expenses directly impact the company’s profit. This should however be taken with a pinch of salt, because the expenses may have shot up in just one quarter due to a one-off factor (like sudden spike in raw material cost etc). If the problem is recurring (high rent etc), then it may be an indicator of poor health.
Ebitda refers to the company’s total earnings before interest, taxes, depreciation and amortization and is also known as operating profit.
Ebitda gives us the real glimpse of the operating efficiency of a company as it indicates how much a company is earning from its core operations during a given quarter before paying any kind of tax or interest on a loan. However, since it completely excludes the debt component, it is not considered to be a true indicator of profitability.
5) Net profit
Net profit is a measure of profitability of the company after taking into consideration all costs incurred during a quarter. Net profit is also known as net income, profit after tax (PAT), net earnings, bottom line (because it is the last line of the balance sheet) etc. It tells you how much money the company finally made after all costs of running the business have been taken out.
6) Profit margin
Profit margin measures how much profit is generated as a percentage of revenue. It can refer to either net profit margin or operating profit margin.
Net profit margin evaluates the profitability of a company after taking into account all expenses. Whereas Ebitda margin helps in analysing how much cash is being generated for every rupee of revenue earned.
7) Interest cost
It is the cumulative sum of the interest paid on loans by the company. Rising interest cost indicates that the company has increased its debt. But that can also indicate expansion in the company and should be viewed along with other components for an accurate judgement call.
Earnings per share refers to net earnings accrued to equity shareholders against each share. This number takes the company’s net profit and divides it by the number of outstanding shares that exist. The total profit figure may be vague to understand for investors, but per-share profit gives a fair indication to the investor on his return on investment.
9) PE Ratio
The price-to-earnings (PE) ratio is measured by dividing share price over EPS and hints at the company’s valuation. A high PE means the company’s valuation is high and the stock is expensive to buy and vice-versa. However, it is important to note that a young company may have a very high or negative valuation as they are yet to reach its scale and profitability. For established companies, a high PE ratio means that the market thinks it will be much more profitable in the future.
10) Q-o-Q comparison
This indicates that the company’s financial metrics like net profit, revenue etc are being compared with those in the previous quarter. For instance, if March quarter numbers are compared with December quarter numbers, then that’s called q-o-q or sequential comparison. However, such a comparison may not be fair for companies that are into seasonal businesses.
11) Y-o-Y comparison
This is the most frequently used comparison for listed companies to gauge growth. Here the metrics are compared with those in the same quarter a year ago. So, for instance, revenue for the quarter ended March 2021 would be compared with revenue for the quarter ended March 2020. It is more relevant as it takes the seasonality factor into account.
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