Reading and interpreting a company’s earnings report can give you a better sense of its economic health and success. But what is “price/earnings multiple,” and how does it help you make decisions about your investment?
In this guide, you’ll learn more about how to read an earnings report and discover how the price-to-earnings ratio (P/E) can help you compare potential investments.
What Is an Earnings Report?
Investors rely on earnings reports to gauge a company’s performance and make informed decisions about its present and future investments. Public companies are required to file an earnings report with the Securities and Exchange Commission (SEC).
These reports are designed to provide the public with information about the company’s financial results for a specific period. There are several different types of earnings reports. Here’s an overview of each.
10-K
Form 10-K is an annual report filed with the SEC. This document is highly detailed, containing an overview of a company’s financial situation as well as its audited financial statements. Investors can use the 10-K to learn about the company’s:
- Financial status
- Legal issues
- Market risk
- Management’s discussion and analysis of financial conditions (MD&A)
Investors and shareholders can rely on the 10-K to provide a polished, detailed assessment of the company’s audited financial data.
10-Q
A company’s 10-Q is a quarterly report also filed with the SEC. Like the 10-K report, it features information relating to the company’s financial performance, MD&A, and disclosures about market risk and internal controls. However, unlike the 10-K, the 10-Q is based on unaudited data.
Annual Report
Public companies provide an annual report to shareholders and stakeholders, though it is also available to the general public. The annual report generally contains a letter from the CEO and reduces the company’s essential data to a user-friendly format, complete with photos and graphs. While easier to read, the annual report contains considerably less detail than the 10-Q or 10-K.
Components of an Earnings Report
While each of the three types of earnings reports will vary in terms of content and structure, investors can generally expect to find the following components.
Press Release/Letter to Shareholders
This section highlights the key takeaways from the rest of the report. You’ll gain a better sense of company leaders’ own evaluation of their performance over a designated period. You may also find summary charts and graphs that offer a quick snapshot of the rest of the data.
Income Statement
A company’s income statement will summarize the company’s revenue, expenses, and profits over the designated period. The income statement will therefore reveal how much the company earned and spent, which translates into their net profit or loss.
Balance Sheet
Balance sheets give a snapshot of the company’s assets and liabilities, as well as shareholders’ equity. Investors can use the balance sheet to determine what a company owns versus what it owes.
Cash Flow Statement
A cash flow statement measures the money actually flowing in and out of a company. This data will reveal where the company is committing its resources and establish whether it has sufficient liquidity and financial flexibility.
Earnings Per Share (EPS)
Earnings per share reveals how much money a company earns for each share of stock. EPS is calculated by dividing a company’s net earnings by the total number of outstanding shares.
Management Discussion and Analysis (MD&A)
This section focuses on any qualitative data that’s potentially affecting the company’s performance. The MD&A section may include market/economic conditions, new product launches, or changes in management.
Key Areas to Focus on in an Earnings Report
When evaluating an earnings report, there are several key areas that investors should look at to determine a company’s present and future value.
Revenue
How much money is the business generating? Is its revenue increasing from previous reporting periods? Answering these questions can help you evaluate a company’s financial trajectory.
Operating Expenses
What is the company spending in order to maintain ordinary business operations? Understanding this figure will contribute to your understanding of the company’s overall efficiency.
Net Income
Looking at an organization’s net income will show you how much money it actually makes once you account for operating expenses. This will indicate how profitable the company really is, as well as how efficiently it operates.
Legal Issues
Don’t just focus on quantitative data. Make sure to also examine things like legal issues that can have a long-term impact on the company’s growth and success.
How to Understand the Price-to-Earnings Ratio
Annual reports will contain many important pieces of business data, including the price-to-earnings ratio, also known as the price/earnings multiple. This important metric helps investors further evaluate the performance of a company based on objective financial data. Here’s how it works.
What Is Price/Earnings Multiple?
A company’s price/earnings multiple (or P/E ratio) is a ratio that measures the business share price against the earnings per share. To calculate the P/E ratio, investors can use the following formula:
P/E Ratio = (Market value per share) / (Earnings per share)
If you do the math, you’ll notice that you can only calculate the P/E ratio for companies that are gaining money. Those that are losing (or not earning more) money have no earnings to put in the denominator. Some investment platforms offer a price-per-earnings ratio calculator for ease of use.
What Is Stock P/E Used For?
Evaluating the stock P/E ratio can help you determine whether a stock is overvalued or undervalued. For example, a company with a high P/E ratio will show stronger earnings potential compared to companies with a low P/E ratio.
In contrast, a low P/E ratio may indicate that the company is presently undervalued. Nonetheless, investors might take some time to evaluate the P/E ratio over time to determine a company’s historic trajectory.
Investors can compare an individual company’s P/E ratio against those of similar companies in the same industry or against a market index such as the S&P 500. Investors are also able to evaluate the P/E ratio of a business over time to gauge entry/exit points for investing.
Forward vs. Trailing Price-Per-Earnings
Investors commonly look at two types of P/E ratios. The forward P/E ratio is also called the “estimated P/E ratio” because it’s calculated based on future earnings and financial projections. This makes it a good tool for predicting a company’s future success, though it’s not as reliable as a P/E ratio anchored in historical data.
To that end, the trailing P/E ratio calculates the company’s price-per-earnings based on past data from a designated time period. This type of analysis is more reliable since you’re using objective data, though it won’t always serve as a predictor of future performance.
Where Do I Find a Company’s Earnings Report?
Shareholders will typically receive an annual report from their company. However, these reports are also available to the general public.
The most reliable way to obtain an earnings report is through the SEC’s EDGAR system, which allows you to search the database by company name. Investors can also use the Earnings Calendar through NASDAQ to track company earnings.
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