How to read an earnings report
The four numbers that matter, and the part the market reads first.
From the top down
The first line is revenue: how much money came in from sales. It shows whether the company is growing, but says nothing about profit.
Then comes the gross margin: how much of every euro of sales is left after the direct cost of production. A margin that falls while sales grow means the growth is being bought with price cuts.
At the bottom come net profit and earnings per share. That's the number that makes the headlines, but also the easiest one to distort with one-off events.
Where problems hide
Look for operating profit, not just net profit. Operating profit strips out the effects of taxes, interest and exceptional items, and shows whether the business itself is working.
Look too at the cash the operations generate. A company can report a profit and burn cash at the same time, if the profit is stuck in unpaid invoices.
If profit grows for years while the cash doesn't follow, that is the question to ask before any other.
The part that moves the price
Professional traders often go straight to the guidance. Last quarter's numbers are history; the new information is what management expects for the quarter ahead.
That's why you see stocks fall after brilliant results, or rise after weak ones. The headline reports the past; the price prices the future.
If you only read one part of the report, read the guidance and compare it with the consensus.
What each number tells you
| Number | Answers the question | The limitation |
|---|---|---|
| Revenue | Is it growing? | Says nothing about profit |
| Operating margin | Does the business work? | Can be swayed by accounting |
| Operating cash flow | Is the money really coming in? | Swings from quarter to quarter |
Key terms in this lesson
- Revenue
- All the money from sales, before any costs.
- Operating margin
- Profit from the core business, as a percentage of revenue.
- Free cash flow
- The cash a company has left after paying for everything it needs to keep running.
Quick check
A company reports rising profit three years in a row, but its operating cash flow is falling. What does that mean?
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