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NEW YORK ( TheStreet) -- We are currently in the belly of the beast of earnings season. The earnings call is the quarterly judgment day for all publicly owned companies. Except for the occasional analyst meeting or press release regarding monthly sales, the earnings call is the only opportunity to get a peek into a company's performance and future expectations.
Personally, I have covered nearly 600 earnings calls for
TheStreet. At Seton Hall University, 10% of each student's grade in my undergraduate class is derived from his or her analysis of an earnings call. This is such an important element of the investment process that I thought that I would share some of my knowledge and experience with you in this edition of "The Finance Professor."
Earnings Calls: 4 Steps
There are several phases to covering an earnings call. Here are the primary steps in the process:
Previewing the call.
Reading the earnings release.
Listening to the call.
Analyzing the call.
Step 1. Preview the Call
This is where you do the preparatory research in advance of the earnings call. Just as study is important to school exam preparation, we need to do some homework before the earnings report is released and the call is conducted. Here is the homework:
Go back in time: Start with the prior quarter's earnings call. You can listen to an archive of the call (online) or obtain a printed transcript (for a fee). Then, query that stock on
TheStreet and read analysts' reports or other commentary to ascertain how the company performed in the quarter, as well as the guidance provided for the most recent quarter. As an example, read
my recent coverage of the earnings call of the casual-dining chain
Note the benchmarks and metrics: This is the most important part of the preview phase. You need to ascertain Wall Street analysts' consensus and range of estimates for EPS (earnings per share) and revenue. See how these consensus estimates have changed over the period of time since the last earnings release.
Also, obtain the expectations for company-specific or industry-specific metrics such as same-store sale comparisons ("comps" in Wall Street vernacular), gross margins, unit sales, traffic acquisition costs and other metrics. Integrate into this analysis any preannouncements (good or bad) or intraquarter press releases, business updates, sales statements, new product releases, management changes, regulatory or legal investigations and other corporate developments or initiatives.
Step 2. Read the Earnings Release
Obtain a copy of the earnings release as soon as possible. A company's earnings press release is typically issued at least an hour prior to the commencement of the call. Some companies will issue earnings after the market has closed and conduct their conference call the following morning.
The earnings press release is made available on the company's Web site or on financial Web sites such as Yahoo! Finance or Google Finance. In addition, some companies will issue supplemental presentations that are available only on the company's Web site.
When you read the earnings release, closely review any stated benchmarks and metrics. Additionally, pay attention to any future guidance or new announcements, such as stock buyback authorization or dividend changes. Also, factor in or out one-time items, such as special tax items, write-downs or impairments, disposal of businesses (discontinued operations) and any new accounting treatments (such as stock-based compensation or "SFAS 123-R"). Factoring in or out one-time items is done to normalize the EPS to prior guidance and consensus estimates.
Finally, look at the balance sheet. Focus on changes in financial position such as cash and short-term investments, inventory, debt, deferred sales and diluted share count.
Step 3. Listen to the Earnings Call
By law, earnings calls are open to the entire public. They are easily accessed by telephone (usually toll-free). To get the telephone number for an earnings call, check the company's Web site (the investor relations section is usually a good place to start) or the earnings release.
The earnings call is typically presented in a four-act format:
Introduction: This is the reading of the "Safe Harbor" disclosure and some instructions from the conference call moderator.
Welcome and overview: This is typically delivered by the chief executive officer or the most senior member of the management team who is present. Sometimes several heads of business units or divisions will also make presentations. Some key metrics and financial results will be disseminated. However, most of this portion of the call is what I call the "commercial."
In the commercial, the company will tell you about its strategic vision for the company, new initiatives, product launches, product enhancements, the business environment and other color commentary. Some CEOs will act as salesmen, while others play the cheerleader. If necessary, during the delivery of a bad quarter the CEO will be somber, cathartic or sometimes clueless.
Discussion of the details: The chief financial officer steps up to the microphone and delivers the financial results for the quarter. You will get most of the key line items and metrics that you prepared for. A slew of income statement, balance sheet and capitalization facts, figures and ratios will be spewed out. The numbers will fly fast and furious and, often times, may be confusing.
Keep a pen and paper handy to scratch down the information. I also suggest having the press release handy to jot down notes.
Question-and-answer session: Analysts and an occasional institutional investor will ask questions of the assembled management team. While management tries to limit each caller to a single question, that seldom happens. Most often, this is the longest part of the earnings call with the least value to the listener, as the analysts rarely ask thought-provoking or deeply probing questions.
Step 4. Analyze the Call
After the call is complete, take the information obtained on the call, together with the earnings press release and your preliminary expectations, and formulate a trading or investment opinion or strategy.
During the call, there are several items you should be aware of in terms of your analysis:
GAAP (generally accepted accounting principles) vs. Non-GAAP (e.g., pro-forma): While all companies must provide GAAP results (e.g., revenue), some companies emphasize non-GAAP results (e.g., traffic acquisition costs -- popular with Internet companies), as management believes that this is most representative of the company's operations. For example, a favorite quarterly result of
Time Warner(TMX) is the non-GAAP adjusted OIBIDA (operating income before interest depreciation and amortization), as opposed to the GAAP concept of EPS (earnings per share).
As a result, analysts will post estimates on a non-GAAP basis to conform with the way in which the company will emphasize its results. Furthermore, the media will tend to focus on results which line up with the analysts' point of view. There is no right or wrong here -- just be careful not to compare apples with oranges.
Management's tone: Listen to the tone of managers' voices or their demeanor on the call. This is a dead giveaway for a red flag being raised. A great example was
InterActiveCorp's (IACI) 2004 second-quarter conference call, when the company's chairman, Barry Diller, threw a temper tantrum. This gave investors and analysts the impression that Diller was not in control. The stock was weaker on the earnings announcement, but Diller's actions during the call set the stock tumbling further.
Irrelevant metrics: Some companies come up with their own metrics, which are nothing but self-serving.
eBay(EBAY) is the champion of creating unimportant metrics. For example, eBay disseminates GMV (gross merchandise value), which is the sum of the value of all of its online listings. That would be the equivalent of
Wal-Mart (WMT) declaring the total value of all of its merchandise for sale.
Lowball guidance: While no company's management would in their right mind provide overly aggressive guidance, be on the lookout for lowball guidance. This is prevalent for the under-promise/over-deliver crowd.
Apple(AAPL) is notorious for giving soft guidance. On the other hand, know when to recognize legitimate upward and downward revisions to guidance. Have handy the analysts' next-quarter and full-year consensus as part of your preparatory work for comparison.
Analysts with clout: There will be a long conga line of analysts asking questions on the conference call. Usually the first two or three are the heavy hitters, but that is not always the case. Know the analysts before you get on the call. Learn to focus on the quality analysts and tune out their lesser peers. For example, on restaurant earnings calls, I know to stay tuned for
Bank of America(BAC) analyst Andy Barrish or
Oppenheimer's Mike Smith, as they are the best in that sector.
The talent pool of analysts will vary from industry to industry. For example, on broker-dealer earnings calls you might as well hang up when the analysts ask questions, because they are all clueless. Those analysts are frequently wrong and offer little benefit to investors.
You can learn about analysts by listening to their media appearances and reading their research products.
Tying It All Together
After the call, take a look at the post-call market reaction to the results and the call itself. Now, compare the company's results with the expectations you researched prior to the issuance of the quarterly results, and interpret the future guidance provided by management. Tie this all together and establish or modify your prior price target for the company. Finally, execute or plan any action in your portfolio.
This week's homework: Prepare for, listen to and analyze an earnings call. There are plenty to choose from; just go to Yahoo! Finance's
conference calls page and take your pick.