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Narrator: Imagine if every three months, you had to report how much money you made, how wisely or unwisely you spent it, and how much of it you had left. And after giving your report, the financial world would judge your performance.
That scenario sounds intense, but this is essentially what publicly traded companies do every quarter when they release an earnings report and hold an earnings call to talk through their financial results.
Earnings events can be important to investors for two reasons. First, earnings events can have a significant impact on price and generate a lot of volatility.
And second, they're a way for investors to understand a company's financial condition.
But before we get into those reasons, let's talk about what an earnings report is. Every quarter, public companies are required to report their financial performance to the SEC. A typical earnings report includes at least three main financial statements—the income statement, balance sheet, and cash flow statement.
The report is usually followed by a press release and public conference call where company management explains the results and answers questions from analysts and investors.
While earnings reports include a lot of helpful information, investors generally focus on earnings per share, or EPS.
Though no single number can tell the whole financial story of a company, EPS is considered one of the most important because it shows how profitable a company is. It's calculated by taking the company's net income and dividing it by the number of outstanding stock shares.
At an earnings event, the actual EPS for the last quarter or year is released and compared to the company's expectations, also known as guidance, for that same time period. The actual EPS is also compared to earnings estimates Wall Street analysts publish.
These comparisons are where volatility can come in. If earnings beat expectations, it suggests the company might be stronger than analysts thought. This can cause the stock price to rise.
However, if earnings are below expectations, it suggests the company might be weaker than analysts thought. This can cause the price to fall. This is why investors generally want EPS to exceed, or at least meet expectations.
When reported earnings are significantly higher or lower than expected, it's called an earnings surprise. The market tends to absorb this information quickly, so depending on the degree that earnings estimates were missed or exceeded, the stock price can jump dramatically.
If you own individual stock, you'll usually see the biggest moves in your account around these announcements. These potential big moves are why speculators sometimes trade around earnings.
In addition to potentially spurring volatility, earnings events can provide insight into a company's operations and values. During the earnings call, company's management typically explains why earnings met or didn't meet expectations. This is a chance for investors to evaluate the health of the company and determine whether it's a good investment.
You don't have to be an expert financial analyst to gain valuable perspective from an earnings event. Whether through your brokerage firm, financial news sites, or a company's investor relations website, it's easy to find earnings numbers online. Along with other forms of analysis, following earnings announcements can help you decide if an investment is right for you.
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