Earnings Reports

Earnings reports are the quarterly filing made by public companies to report their fundamental performance. Earnings reports are filed at the end of each quarter, with most companies filing in January, April, July, and October (these months will vary company to company). A company’s earnings report includes items such as net income, earnings per share, earnings from continuing operations, and net sales.

Many companies will report a set of earnings according to Generally Accepted Accounting Principles, or more commonly known as GAAP. This is a common set of accounting principles, standards and procedures that companies use to compile their financial statements. GAAP are a combination of authoritative standards (set by policy boards) and simply the commonly accepted ways of recording and reporting accounting information.

GAAP are imposed on companies so that investors have a minimum level of consistency in the financial statements they use when analyzing companies for investment purposes. GAAP cover such things as revenue recognition, balance sheet item classification and outstanding share measurements.

In addition, a company will also issue what are called non-GAAP results, which often exclude certain one-time events, charges, or financial gains. This non-GAAP figure is typically compared against the expectations of the various brokerage firms to determine whether the firm came in ahead of or behind the consensus analyst estimate.

Quarterly earnings reports will also often include a forecast for the coming quarter(s) and sometimes the rest of the fiscal year.

Think of an earnings report as a “report card” for a company. These quarterly reports let shareholders know exactly how well a company has performed during the past quarter. A company’s results will often be compared versus the same quarter a year ago. In addition, analysts and brokerages will issue estimates of what the company will earn in the given quarter. More often than not, the results are measured against these expectations to see if the quarter was successful or not. Surprises can occur to the upside (stronger-than-expected results) or the downside (weaker-than-expected results).

Let’s take a look at company ABC’s second-quarter earnings report, where the company announced that it brought in 35 cents per share. In last year’s second quarter, ABC earned 30 cents per share, and expectations called for 33 cents per share. These results definitely qualify as a surprise, topping both analyst expectations and results from a year ago. As long as the company didn’t report any negative news, such as weak expectations for the current quarter, the stock will more than likely gap higher upon the open, or at least advance during the day’s trading.

If the earnings came up short of expectations, we could have seen the stock gap lower or at least move lower throughout the course of the day.

However, what if a company tops expectations, year-ago results, and issues a better-than-expected forecast and the stock drops? This situation suggests that expectations were too high from the individual investor heading into the earnings report. Of course, the opposite is true should the stock advance in the face of weaker-than-expected results.

Unlike most events that occur in a stock’s history, a company’s earnings report is a known event with a set date. This is an opportunity that a trader can take advantage of by playing options ahead of the earnings announcement as well as after the company reports its results. While playing options ahead of the firm’s earnings report is frequently risky, though it can result in large profits, playing a stock or its options after the earnings report can be just as profitable, while reducing some of the risk since the news has already been released. An unwinding of sentiment toward the shares (whether its bears jumping on an outperforming stock that reported strong earnings, or bulls selling their long positions on an underperforming stock that reported weak earnings) could see the security continue its trend for a considerable period of time.

Furthermore, a company’s earnings history can offer up strong clues as to the financial health of the firm. A corporation that has a long history of matching or exceeding the consensus analyst estimate could not only indicate that the firm is likely to at least match expectations with its next report, but it would also show that the company is fundamentally strong. Meanwhile, a company that has consistently missed the Street estimate would indicate that the firm is struggling from a fundamental perspective.

A company’s earnings report gives an investor valuable insight into the fundamental health of a firm. This known event can also be a great catalyst for an option trade.