Quarterly Results can sometimes feel like a feeding frenzy as Wall Street analysts and financial news anchors descend on the headline numbers and tear them apart. Judgment is passed according to how the EPS and Revenue compare to Wall Street expectations, with the markets reacting instantly and often violently. Wall Street analysts like to play this game because it creates trading activity among their clients, and this in turn generates execution fees. In the midst of this feeding frenzy, you need to keep your head, and you certainly shouldn’t follow Wall Street’s lead blindly. In fact, there is an advantage to those analysts who take a deep breath and look at the numbers in a way that Wall Street doesn’t. Here are 6 key things that I look for in every quarterly report.
- Trends in Sales and Margins
For Wall Street, you’re only as good as your last set of numbers. However, a good analyst understands that quarterly numbers include a large degree of “randomness”. In the real world businesses don’t increase their sales in a nice uniform way (although certain management teams try to massage the numbers to make it look like they do). I like to look at sales and margins over a number of quarters to see if there’s any discernable trend forming. Only by looking at the last 6-8 quarters can you really determine if there’s something going on that’s worth paying attention to. Focusing on a single quarter’s numbers in isolation can be a dangerous game and will often lead to false conclusions.
- Outlook Statement
This is one of the most important parts of the quarterly results, and is usually included towards the end of the press release. Look for any change in tone versus the last quarterly report. Companies these days often issue guidance for the current quarter – they’re already a few weeks into the quarter so management usually has a good sense for how it will turn out. Any change in full year guidance is particularly significant, as companies will try not to alter this unless they have to. Again, don’t get caught up with one or two quarters but use this information, together with your analysis of revenues and margins, to inform your long-term view.
This is the one figure that Wall Street pays the most attention to, yet is probably has the least value for a fundamental analyst. Whether it’s a miss or beat, you can bet that Wall Street will overeact to the number. This doesn’t mean you should ignore EPS completely. Stand back from the number itself to understand if there are any key trends worth paying attention to here. Is EPS moving due to revenue/ margin trends? Is there a large change in share-count? Or is there a one-off cost involved, in which case you need to understand the nature of this one-off cost and to what extent it really is a one-off.
- Cash Flow
Look at cash conversion trends. One quarter of cash flow is almost meaningless (cash flow tends to be even more volatile than earnings). However over a few quarters is there a discernable trend here? If cash conversion is particularly weak or if it has significantly deteriorated, this is worthy of further exploration. For a more detailed discussion of cash flow see this recent post.
- Balance Sheet
The quarterly balance sheet is valuable as it provides the most up-to-date snapshot you have of the financial position. If you’ve identified already that the company is vulnerable from a balance sheet perspective, look closely here for signs of further deterioration. This statement shouldn’t change materially from one quarter to the next – and if it has you need to understand why. Is it due to a capital-raising event, a big investment, or because of the underlying operations?
- Conference Call
Much of the color will come via the conference call, in particular the Q&A section. Although much of the Q&A can be dominated by dumb questions from Wall Street about small movements in insignificant line items, it’s still worth listening to. Ideally, before the conference call starts, you will have run through items 1-5 above and got a good sense for the key trends and what you want to get out of the call. The nuance provided on the conference call can help inform your view of the items you have studied above.
Also don’t forget the more detailed things that you would look for in the 10-K also apply to the 10-Q. My recent blog post, 10 things to look for in the 10-K applies equally here.