The Finance Professor: Beginner's Guide to Earnings Calls

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.