earnings: How to read corporate earnings & balance sheets to make investing decisions

There are numerous factors that influence price movement of stocks, such as global cues, market sentiments, political developments and so on. But the most critical factor that really influences market sentiment is quarterly earnings.

Earnings reports are released four times a year and are followed very closely by market participants. Growing earnings are a good indication that a company is on the right path to providing solid returns to investors and vice versa. Also, companies tend to pass on part of their profit to shareholders in the form of a dividend during earnings announcements.

The numbers in a company’s financial statement reflect the health of the business and its products, services and macro-fundamental events.

Thus, a balance sheet is a snapshot at a single point in time of the company, such as assets, liabilities and shareholders’ equity. The earnings season is typically a time of increased volatility in stock prices, which can mean additional risk and also opportunity for investors.

Earnings drive stock prices. The release of the earnings guidance is closely watched by investors, as companies use it as a key mechanism to communicate forward-looking information to investors. Actually, when company’s quarterly financial statements are released, they offer an insight into how the company performs and what its prospects may look like over the near term.

So, investors should maintain a close watch on a company’s quarterly report to help estimate future earnings. Quarterly earnings report can serve as a bellwether for similar companies that still have not reported their numbers. Most importantly, management decisions regarding investments, R&D, brand development and such expenditure, which can generate revenue in future also tells about clear prospect of the company to investors.

Other than net profit, there are a few more terms such as gross sales, net sales, debt structure, expenditure, operating income and earnings per share (EPS) that can help investors get a better understanding of where the company stands and to play the earnings theme. In addition, investors can have a close look at the company’s short-term and long-term goals.

The earnings season is a binary event for the market and, therefore, a stock can move either way based on the outcome of the earnings report. One cannot conclude much by looking at the numbers in quarterly financial statements alone. It is essential to compare the numbers with prior periods to gauge the direction in which the company is moving. Investors should always compare the numbers from the same quarter a year before or a quarter before to make any decision regarding holding or liquidating their stock positions.

A long-term investor need not have to bother much about the short-term volatility and should abstain from getting lured into making a quick profit on earnings. They should check other factors such as policies of the company and other fundamentals before investing.

Chairman and MD, SMC Investments and Advisors