Anyone just beginning to read financial news will need a quick primer on the terms commonly used. To help you better understand what you read, we will briefly explore terms commonly encountered in market news. In particular, company earnings announcements and where you will see these words, what they mean, and the significance they have.
Earnings announcements
An earnings announcement is a company’s public statement to reveal its profitability for a certain period. For example, an earnings announcement often details profit for a quarter or a year.
Before a company makes an earnings announcement, equity analysts study past announcements and other metrics to develop earnings estimates, speculating on the earnings announcement figures for the company. Traders and Investors also often study the company’s metrics to speculate on the company’s profitability. As a result, analysts often move the company’s share price up or down, depending on the estimated profitability.
Once the company makes the earnings announcement, the company’s share price will move even more significantly. The share price will go up if profitability is high and down if profitability falls short of the speculated or estimated figure.
Example of earnings announcements
To illustrate, here are excerpts from a false earnings news report regarding a fictional company called Exten Inc.:
Exten Incorporated announced its fiscal 2021 Q4 results following the close of markets, reporting non-GAAP earnings per share of 67 cents, a rise of 17% from the previous quarter, coupled with a net income of $250 million, an increase from $235 million. In addition, earnings guidance from Exten Incorporated fell within range, with EBITDA, net income from ongoing operations, and free cash flow beyond the high end of their respective guidance ranges.
Highlights from the fourth quarter of 2021 include:
- Cash and cash equivalents of $128 million
- EBITDA increase of 19% from Q3
- Free cash flow of $35 million, up from Q3’s $32.7 million
- Total debtincreased from $95 million to $100 million.
However, despite the 17% EPS increase, Exten Incorporated fell well below the analyst earnings estimate of 71 cents. Coupled with Exten’s increasing total debt, some analysts question its ability to service its debt moving forward.
Four Common Terms in an earnings announcement and What They Mean
This earnings announcement contains four terms commonly used in finance. Knowing what these terms mean will help you understand what the announcement is reporting.
1. Net income
Net income delineates a company’s total earnings or profit at its most basic. You get net income when you subtract all expenses (including tax expenses) from revenue. When a company’s net income increases, it’s usually a result of either increased revenue or slashed expenses. A rise in net income is generally perceived as positive and contributes to a stock’s performance.
2. EBITDA
EBITDA stands for earnings before interest, taxes, depreciation, and amortisation. EBITDA is calculated by deducting operating expenses from revenue and adding depreciation and amortisation to operating profit. EBITDA can be used as a proxy for free cash flow since it accounts for the non-cash expenses of depreciation and amortisation.
EBITDA is the line item above net income that excludes other non-operating expenses and interest expenses, and taxes on a company’s income statement. One can argue that EBITDA paints a rawer profitability image than net income. Though some advocates of EBITDA claim that it’s a less complex view of a company’s financial health. Many critics claim that it oversimplifies earnings and can construct misleading measurements and values of company profitability.
3. GAAP
As a new investor, it’s essential to know the distinctions between like measurements because the market allows firms to advertise their numbers in otherwise regulated ways. Often companies will disclose their numbers using either GAAP or non-GAAP measures. GAAP stands for generally accepted accounting principles. It outlines rules and conventions for reporting financial information, and is a means to standardise financial statements and secure consistency in reporting.
When a company discloses its earnings and includes non-GAAP figures, it wants to provide investors with an arguably more accurate depiction of its health. For example, by removing one-time items to smooth out earnings. Although, the further a company diverges from GAAP standards, the more room is allotted for creative accounting and manipulation.
4. EPS
Finally, earnings per share (EPS), is one of the most common items highlighted in an earnings announcement, provides investors with insight into a company’s earnings health and often affects its stock price. EPS is calculated subtracting the preferred dividends (assuming, for simplicity that Exten doesn’t pay dividends on preferred shares), from the net income and dividing that difference by the average number of outstanding shares.
In the case of Exten, its current quarterly EPS is determined by dividing its $250 million in net income by the company’s 37 million shares outstanding. When EPS is reported it is usually compared to earnings from either the proceeding quarter or the correlating quarter in the previous fiscal year. It is also used in rudimental’ valuation calculations like the price-to-earnings (P/E) ratio.
Cash on Hand, Money in the Bank
Most news reports look at how companies manage their money. Specifically, how much they have in available cash flow, total debt, and assets, they have accessible in cash equivalents. For instance, short-term government bonds that can be sold to settle debts.
In Exten’s announcement, free cash flow is increasing. After all of the expenses have been laid out to maintain the business’s continuing operations, and the sum of cash the company has on hand is growing. Moreover, on Exten’s balance sheet, the company exhibits equivalents of $128 million, which can be converted into cash if required especially if the firm’s total debt increases or income hits.
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