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What you should know about a company’s earnings reports

 

Provided by RBC Wealth Management
and Dave Dupont

For the most part, earnings are synonymous with profit. They represent what a company makes after subtracting the costs of running the business — taxes and expenses.

Investors often look at a company’s earnings as an indication of the company’s relative strength. Strong earnings provide companies with the ability to reinvest, start new operations, or pay dividends to shareholders. Over the long haul, strong earnings usually correlate with strong share prices.

Although the concept is simple, determining how strong a company’s earnings are can be complex. To be sure you’re accurately evaluating a company’s performance, you want to see how the current quarter’s earnings numbers compare with the previous quarter or the same quarter one year ago. You’ll also want to examine its historical growth rates and see how those rates compare with the company’s competitors. Solid trends of increasing earnings can suggest a company’s earnings can be labeled “strong.”

Companies know that quarterly earnings tend to have a strong impact on the company’s share price. The elements of the earnings report are as important as the numbers themselves. Usually companies will provide two kinds of earnings: those based on Generally Accepted Accounting Principles (GAAP) and others termed operating earnings. Unlike GAAP earnings, operating earnings typically exclude one-time charges and write-offs, so they give analysts and investors a more accurate picture of what is going on behind the business.

In general, the type of business it is and where that business is in its life cycle also will affect what the earnings numbers mean. For example, a company may be devoting significant financial resources over the near term in hopes that the new product will generate significant revenue, so its earnings could be low now but higher down the line. Conversely, a company that appears to be generating solid earnings quarter after quarter may not be investing enough back into the business and may run into problems down the road.

You also should consider management changes and strategic execution in conjunction with earnings. Significant changes may underlie issues in the execution of the company’s strategy. SEC filings can provide important information on subjects such as how much money is going toward compensation or if the company is investing more in businesses that are outside its main business line.

Keep in mind that a company’s share price can jump or fall dramatically based on its quarterly performance. Take those gyrations in stride and look at how those quarterly earnings reports fit into a long-term pattern.

This article is provided by Dave Dupont, a Financial Advisor at RBC Wealth Management. RBC Wealth Management does not endorse this organization or publication.


 

RBC Wealth Management, a division of RBC Capital Markets LLC, Member NYSE/FINRA/SIPC

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