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.
Knowing how to understand and analyze a company's earnings call is a crucial element of the investment process. By doing your proper research and preparations, you can learn what to listen for and how to focus on and scrutinize the right factors, you can become a savvier investor.
How do you go about doing your due diligence in listening to an earnings call? There are several phases to covering an earnings call. Here are the primary steps in the process you will need to take:
- Previewing the call.
- Reading the earnings release.
- Listening to the call.
- Analyzing the call.
Step 1. Preview the Earnings Call
This is where you do the preparatory research in advance of the earnings call. Just as studying is important prior to a test, 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 or obtain a printed transcript. Then, search that stock 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.
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. The more preparatory materials you have, the better the idea you can ascertain about the company will be.
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 both on the company's website or on financial websites. In addition, some companies will issue supplemental presentations that are available only on their website.
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 website (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 (CEO) 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 can essentially be referred to as 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. This commercial can act as encouragement for shareholders - or, in the event of a disappointing quarter, an apology to them.
Discussion of the details: The chief financial officer (CFO) 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 - though, if the analysts don't ask sufficiently probing or interesting questions, it won't be the most valuable part.
Step 4. Analyze the Earnings 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 operating income as a financial measure.
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 may focus on results which line up with the analysts' point of view. There's not necessarily a 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 Tesla's (TSLA) earnings call for their 2018 first quarter. CEO Elon Musk was agitated, volatile, and dismissive, a fitting button to what had been a rough quarter for Musk and his company. Investors and analysts feared that Musk was no longer in control, and shares immediately dipped as a result.
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 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.
You can learn about analysts by listening to their media appearances and reading their research products. Perform a good amount of research on some of the more well-known analysts prior to the earnings call, and if one you hear during one sounds like someone who knows what they're talking about, make sure to do research on them as well to see just how they've fared in their career.
After the Earnings Call
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. With the right knowledge of how to interpret an earnings call before, during, and after it happens, you can make sure you're as well-prepared as you can be.