Understanding Earnings: A Beginner's Dictionary

Financial markets are full of jargon and, unfortunately, just as full of people who assume that everybody understands it all. Earnings season is particularly frustrating to those just beginning to take an active role in managing their portfolios. Earnings reports are difficult enough to interpret when you do understand the words used, but without that understanding you have no chance. If you are in that position, the explanations of frequently heard expressions relating to earnings below may be useful:

Earnings Report: Public companies are required by law to file a report of their activities for each three month period, or quarter. Most companies do so in January, April, July and October for the previous three months. The report must be filed with the SEC, and is known there as a 10-Q.

The 10-Q is in two sections. The first is the financial information and will detail the amount of money the company brought in, the amount it spent, and the profit left after expenses. It will also contain a discussion of the current financial condition of the company by management. The second section contains other information, such as any outstanding legal proceedings against the company, any defaults that may have occurred on obligations and any risks to be considered going forward.

Earnings Release: A company will release its Earnings Report at a pre-set time, along with a summary provided by management. The summary release will usually highlight the good news and offer excuses for the bad.

Earnings Call: Following the release, management will often host a conference call with analysts where more detail is given and questions can be asked.

Top Line: The top line is the amount of money that the company brought in during the quarter, also known as revenues. It is basically the sales for the quarter, but can include other monies, such as from the sale of a business unit. These are usually reported as “extraordinary items” and should be deducted from the top line when comparing sales to previous quarters.

Bottom Line: This is the total profit booked after operating and other expenses are deducted from revenue.

GAAP vs. Non-GAAP: GAAP stands for Generally Accepted Accounting Principles, a set of rules designed to standardize how companies report. If, for example, one company includes payment expected or made up front for leases signed in their revenue number, and another only adds them as they become due and are paid, comparing the two numbers is difficult. In general, GAAP reporting is considered a better guide for investors.

EPS: EPS stands for Earnings per Share. It is calculated by dividing the total profit by the number of shares in circulation. It is a better measure for comparison purposes than total profit. If two companies each make $1 Million in a quarter, but one has 1 million shares in circulation and the other 2 million it follows that the shares of the first company, with an EPS of $1 are more valuable than those of the second, with an EPS of $0.50.

EBITDA: Stands for Earnings Before Interest, Tax, Depreciation and Amortization. By taking out these variables and accounting measures, many believe that a better picture can be gleaned of the company’s pure profitability.

Free Cash Flow: The amount of money generated for the company to use or distribute. Free Cash Flow is a good measure of a firm’s liquidity, and its ability to survive in tough times.

Margins: The percentage of revenue that is kept as profit after operating expenses. There are two ways to increase margins; by increasing prices, which can negatively impact sales, or, preferably, by decreasing costs.

Expectations: Analysts that cover companies estimate future earnings and revenues. An average of those estimates gives the consensus expectations. Those expectations are priced into the stock before the release, so performance in relation to them is, in the short term, more important to the stock’s performance than the actual number.

Whisper Number: Occasionally traders expect results that differ from the published expectations, based on rumors or rapidly changing market conditions. Those estimates become the whisper numbers and are often priced into the stock. This can lead to a reaction other than what would be expected based on published estimates.

These are some of the more common terms that investors will come across as analysts and commentators discuss earnings. There are others, but an understanding of the above will help to make some sense of most of the commentary you hear. For example, when a company reports what looks like decent earnings that are an improvement on the previous quarter, then the stock might do a good impression of a lead balloon - it sinks, and fast.

The reason, say pundits, is "obvious," and could give reasons such as: A disappointment on the top line, the bottom line being reported on a non-GAAP basis, disappointing guidance or the old favorite, a miss of the whisper number. Now you know what they're saying, and can better understand the terminology used.

Check out this guide to interpreting an earnings report.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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