Quarterly Earnings Reports

The Fallacy Of A Quarterly Earnings Report

Publicly traded companies must release quarterly earnings reports 4 times a year. The contents of these reports can make or break a share price, and shake a CEO’s foundation in the company. So, is it healthy for a business to base performance on quarterly benchmarks? 

In this article:

  • What is a quarterly earnings report?
  • When are quarterly earnings reports released?
  • Earnings estimates, consensus estimates, and earnings per share (EPS)
  • What is wrong with quarterly benchmarks
  • Retained earnings to market value formula

What Is A Quarterly Earnings Report?

In business, the year is divided up into 4 fiscal years, also known as quarters. A quarterly earnings report is a statement a company puts out at the end of each quarter, for the preceding 4 months. It is a display of performance that details the company’s gains or losses.

When Are Quarterly Earnings Reports Released?

Companies that follow the standard calendar year (January-December) release quarterly earnings in these months: 

  • 1st Quarter (Q1) ends March 31st: report released in April 
  • 2nd Quarter (Q2) ends June 30th: report released in July
  • 3rd Quarter (Q3) ends Sept 30th: report released in October
  • 4th Quarter (Q4) ends December 31st: report released in January

Companies that run on a fiscal year have different dates that they release quarterly earnings. This is because their revenue model does not fit into the standard calendar year.

Quarterly Earnings Reports: Private vs Publicly Traded Companies

A publicly-traded company has public stock available for purchase. They undergo an initial public offering and then are launched on stock exchanges where investors can buy a piece of the business. Publicly traded companies must comply with reporting standards such as GAAP for the U.S, and IFRS for international markets. Also, they are required to publicize quarterly earnings to the U.S. Securities and Exchange Commission along with various state business agencies. 

Private companies are private and do NOT need to publicize quarterly earnings. Although most do have quarterly earnings reports, they are only available to internal management, shareholders, or prospective venture capitalist, and angel investors. Depending on the business structure, private companies must comply with state regulatory agencies. However, these compliance measures are NOT made public and thus have little effect on the company.

What Is In A Quarterly Earnings Report?

Quarterly earnings reports are a highly anticipated update of the 3 main financial statements: Balance Sheet, Income Statement, and Cash Flow Statement. Important metrics and ratios on watch are net sales, net income, expenses, and earnings per share (EPS). Internal management, shareholders, and external analysts use this report as a benchmark to evaluate actual earnings vs earnings estimates.

Moreover, the quarterly earnings report includes a comparison to prior earnings. Typically, you see a snapshot of the most recent earnings alongside same quarter earnings from the year prior. The SEC mandates that a company also insert a policy disclosure in the quarterly earnings report. This is a statement of business policies and procedures that could affect investor earnings. The disclosure helps investors determine whether the business’s actions will be profitable, and the risk associated with the investment in a volatile market. 

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We believe that a fundamental measure of success will be the shareholder value we create over the long term —Jeff Bezos

CEOs leave their mark with an analysis of the company’s quarterly output. In this statement, the executive will highlight company metrics they are monitoring for overall success. In addition to where the company started under their leadership, and where they are heading for the future. These statements are weighty in times of high earnings and low earnings, to quell investor fears of instability.

What Is A 10Q vs 10K?

Publicly traded companies release a 10Q or 10K following the quarterly earnings statement. The 10Q/10K isn’t released in tandem with the report, but shortly after. It is a legal document that must be filed quarterly with the Securities and Exchange Commission. The form 10Q is filed for the first 3 quarters of a year, and the 10K is filed annually for the last quarter of the year, with the 10K being a more detailed summary of the year than its counterpart.

The 10Q or 10K is a thorough brief of the quarterly earnings report. It is supplemental with more financial insights and information into business performance. Investors and shareholders use it as a way to judge their investment more intimately, while the public has access to it as an SEC compliance measure.

Earnings Estimates

Investors use quarterly earnings reports to measure whether a company is a viable stock investment. They do this by comparing quarterly earnings reports to predicted earnings, called earnings estimates, from financial analysts. The release of quarterly earnings reports can momentarily rattle stock prices when estimates aren’t met, resulting in investors bidding up stock prices or a sell-off. Thus exciting the fervor around whether recent company earnings performed at or better than the forecasts.

Earnings Per Share (EPS)

Earnings per share are the star metric in a quarterly earnings report. It shows the amount of money a company made per share sold after dividends were paid out.

Earnings Per Share Formula

Earnings Per Share (EPS) = (Net Income – Dividends Payments) / Average Shares Outstanding

Earnings per share estimates are very influential to company stock prices. Companies strive to be over the estimates of market analysts, even if it means less of a decline in earnings. When earnings per share experience a quarterly increase, it means a company is profitable and there is more faith to invest. A decrease in earnings per share results in a fall in stock price, but it tends to be short-lived—unless it is an extreme case of dire straits.

Consensus Estimates

Much like sportsbook betting follows a points spread, publicly traded companies get consensus estimates. Analysts will compile many earnings estimates into one consensus estimate, to predict the operational success of a company. The consensus estimate falls somewhere in the median of all estimates from equity analysts.

Wall Street analysts who work for financial firms or reporting agencies will cover a company’s stock. They base estimates on a variety of sources, including but not limited to annual or quarterly reports, forecasts, and prediction models. Analysts will go to great lengths to produce estimates, like studying the particular industry and meeting with management for financial “guidance.”

A CEO analyzing consensus estimates against a quarterly earnings report

Market analysts will forecast EPS quarterly or annually, to gauge stock investments. A company’s quarterly earnings are compared to the consensus as a measure of strength. Consensus estimates also hold value for the public, who is not privy to internal financial models. However, they can be a heavy hand on the market because some business leaders issue guidance in a manner that sways the consensus

How does the consensus estimate have an impact on a business you ask? Companies that have continually low estimates generally perform favorably in the stock market. With low bars to meet, quarterly earnings will beat estimates, and share prices rise. In that sense, they make for a volatile market where everyone is vying for an advantageous share price, investors and CEOs alike.

What Is An Earnings Surprise?

An earnings surprise is when earnings are way higher or lower than the consensus estimate. A higher earnings surprise is called a positive or upside surprise, and a lower earnings surprise is called a negative earnings surprise. Outperforming earnings projections is ideal because it makes shares more appealing to purchase. The opposite can be said for a company that underperforms.

What Is Wrong With Quarterly Benchmarks?

Due to quarterly earnings reports, Wall Street is inevitably chopped up into quarterly seasons. Each season has the potential to bring wild fluctuations in stock prices for publicly traded companies. Even more, CEOs fear the repercussions of immediate market loss, due to lackluster quarterly earnings reports, because it could mean a management shake-up.

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Surveys show that more than 80% of CEOs and CFOs are willing to sacrifice research and development spending—and half would delay starting new projects that would create greater long-term value for their companies—just to meet a quarterly earnings target —Bina Venkataraman in The Optimists Telescope

Undeniably, CEOs are looked at as the scapegoat when earnings fall. So they often fall prey to the short-term whims of Wall Street analysts. They’ll cut costs, pad earnings, and issue misleading guidance, just to hit or outperform the consensus. This quarter-to-quarter play calling stifles progress because it sacrifices valuable time and capital towards long-term investments. 

Meanwhile, investment fund managers are annually rewarded for earnings on portfolios. The more their portfolios earn in a year the more the end-of-year bonuses are. So the long-term mission of any one company holds no value to the portfolio if it is underperforming each quarterly season.

A company following quarterly seasons

So then, is a quarterly benchmark something a company should base success on? A fundamental analyst would say NO, and instead, they would look at how quarterly earnings reports have changed over greater chunks of time. The McKinsey Global Institute found that corporations who focused on long-term goals versus quarterly benchmarks earned 47% more than their counterparts from 2000-2015.  

C-suite compensation packages are tied to company quarterly earnings. So corporate management is incentivized to match quarterly estimates. To encourage a different attitude towards quarterly earnings reports, compensation packages should reward long-range goals versus quarterly marks. Plus that would replace instant gratification with loyalty to the company. 

Measuring Retained Earnings To Market Value

One way to move company valuation away from quarterly earnings is by measuring retained earnings to market value. Retained earnings to market value zooms in on a span of time (usually measured in years), comparing how much a company is retaining and its change in stock price. Ideally, a business should be creating a 1:1 ratio of profits—$1 of income per $1 of accumulated income. 

Retained Earnings to Market Value Formula

Retained Earnings to Market Value = EPS change (in years)  / Total Retained Earnings (in years)

A low earning per share wouldn’t matter if retained earnings to market value are high. It means that management has decided to retain earnings and reinvest in research and development for larger long-term gains. 

Don’t Let Quarterly Earnings Distract Your Success

It is all speculation and mind games. As a CEO or Founder of a company, pay no mind to the consensus hype and focus on driving the company mission. As an investor, align with companies that are looking at the long game. Ultimately the best investment will be an innovative company making strides in their industry, not the stock markets’ flavor of the week.

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