Part II: How To Use Earnings Reports In Your Stock Trading
In part I of this article, we looked at what an earnings report is and what it contains. Now let’s get to the heart of the matter – how to read a company’s earnings report for use in your trading.
Let’s not beat around the bush – this may or may not get boring for some of you. But if you’re interested in trading, this is the kind of stuff that separates the winners from the weepers.
You’ll want to spend plenty of time on the financials here. This is going to tell you how the company did in the most recent quarter, and how that quarter compared to either the quarter before it or the same quarter last year. They will show you if revenues have grown or receded, the cost of bringing in business, and many other key data points.
Let’s get stuck in…
The income statement
This is the very first page of the financials.
There are a few metrics that basically tell you how much money the company is making. On the 10-Q income statement, companies usually compare this month’s income to the same quarter last year.
Here’s a look at the first page of Apple’s financial statement for Q2 2021.
Total net sales
Total net sales is how much the company earned during the quarter. This is not the best indicator to look at, however, because it doesn’t factor in the cost of acquiring those sales, such as staff, rent, and keeping the lights on.
What it does do well is give you a quick snapshot of whether the company is trending well in terms of its sales, relative to its prior performance. So it offers a bird’s-eye view of how well the company is doing.
For example in the screenshot above, we can see that Apple’s total sales were 21-odd million US dollars more this quarter compared to the same period last year.
But in the grips of a pandemic, where recovery isn’t exactly on pace, you could say that a 21 million dollar increase, when a considerable number of their stores across the world were still closed, is an even bigger feat than it seems at first!
See how reading into the numbers like this can be more fun, rewarding and thought-provoking than simply taking someone’s word for it?
Cost of sales
The cost of sales shows us how much it costs the company to produce and deliver the goods and services that are sold. For Apple’s hardware business, for example, this includes the cost of manufacturing, packaging and shipping for products such as the iPhone and the iMac.
This is usually broken down into the categories “product” and “service”. Almost none of the items we cover are ideal for looking at in isolation – and cost-of-sales falls squarely into that category. But it will tell you certain things at first glance – like if raw materials are becoming more expensive, for example.
Under the cost of sales, you’ll often find the row for gross margin. Simply put, this is the total sales minus the cost of producing those sales. However, the gross margin doesn’t include all expenses, only those involved with the manufacturing and delivery of products and services. Another expenditure comes in the form of…
These are expenses that include costs such as marketing, research, etc, which add to the cost of running the company.
It can be quite difficult to glean much insight into the total number here. Instead, look at the breakdown to determine whether an increase in operating expenditure is good or potentially bad for a company.
For example, Apple’s operating expenditure according to our screenshot shows that operating expenses have increased. But should you be concerned if you want to enter a long trade? Probably not…
The fact that more expenditure is being incurred under the heading “research and development” is probably a sign of health. You could make the assumption that they are putting more money into product development, which will only increase its future growth potential.
This is the big one.
Ever heard of the term “bottom line”? Well, this is it – referred to as such because it’s quite literally at the bottom, and double-underlined.
This is an excellent figure to look for when you need a quick assessment of the company’s performance. It tells you, after all is said and done, added and subtracted, how much money the company made or lost when everything is tallied up.
Although companies always seek positive net income as their long-term goal, it’s very important to note that it’s not necessarily always a bad sign when net income is negative territory.
Some businesses, and tech businesses, in particular, take a really, really long time before they become net positive. Take Amazon and Netflix as two examples of tech titans who are now net-income positive, but who were not for much of their existence.
Earnings Per Share (EPS)
This is the Wall Street banker’s favourite stat to trot out during earnings season. Earnings Per Share takes the company’s net income and divides it by its number of total shares. Basically, it’s what would happen in theory if the company took every cent of its net income and spread it evenly amongst every share.
Obviously, it’s a hypothetical stat – no company would ever do this. But it’s an excellent way for you to compare how companies are doing against each other. This gives you the “lowest common denominator” to help you add more context and objectivity when comparing one company’s performance against another’s.
This is an important one to remember, so here’s the formula:
Earnings per share (EPS)= Net Profit / Total number of shares traded.
Other things to look out for
It’s always a good idea to look at the legal proceedings in the 10-Q report in case any scandals may have flown under your radar. A patent challenge from a major rival could be huge.
You may also want to look at the company’s commentary to see how they’re looking to tackle the issues facing them such as COVID-19, however, it’s worth noting that the commentary will likely be skewed in favour of the company, so always try to read between the lines.
Hopefully, these articles have given you a good starting point for finding and using company earnings reports for your stock trading. The next time you review a report, make sure to have this page bookmarked – you’ll eventually get the hang of how to understand earnings. To broaden your research, consider using a broker that gives you all the tools you need, in one easy place. TIOmarkets is a great option – our MT4 and MT5 platforms give you plenty of research tools to help you choose shares with more confidence, such as advanced charting tools and powerful technical indicators.
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