With Woolworths Limited (ASX: WOW) scheduled to report its full year results for the 2016 financial year (FY) on August 25, many investors will be sharpening their pencils in anticipation of the release.

According to Reuters, analyst consensus estimates show a decline in earnings per share (EPS) from 195 cents per share (cps) in FY 2015 to 125 cps in FY 2016.

If the consensus figure turns out to be on the mark, this will equate to an EPS decline of 36% year on year.

For investors considering buying, holding or selling shares in Woolworths, the upcoming results will be critical for assessing whether the trend of declining earnings is over or not.

Upside or downside surprise?

Given the significant negativity towards the stock it’s quite possible that investors have become too pessimistic about the earnings outlook for Woolworths – a surprise on the upside is possible.

On the flip side, despite investors being well aware of the competitive pressures being faced by Woolworths, it’s equally possible that the market has failed to fully comprehend the pressure competition is having on margins.

3 key metrics to watch

Losses incurred within the Masters Home Improvement division are likely to receive less attention this August given that management has announced it will sell or close the division.

The following three metrics will however receive close attention from investors.

The Australian Food, liquor and petrol division reported an earnings slide of 31.7% to $1.3 billion in the first half. There were numerous drivers of this decline including a reduction in average prices and increased investment in store labour.

The earnings margin within this division is hugely important to the overall profitability of Woolworths. With the margin dropping 2.2% from 7.4% to 5.2% this will be the most closely followed metric when the group reports.

The General Merchandise division which includes the Big W store operations recorded an earnings decline of 38.7% to $67.3 million during the first half of FY 2016. The earnings margin slid from 4.6% in the prior corresponding period (pcp) to 3%.

Investors will be looking for signs that this downward trend is slowing or ideally reversing. Given the success Wesfarmers Ltd (ASX: WES) has had at improving the profitability of its Kmart business, shareholders are hoping for a similar result at Big W.

The Hotels division is a significant contributor to the group, providing earnings of $135 million in the first half of the year. This result was down 6.6% however and the earnings margin declined by 1.6% to just under 17% in part due to rising costs.

Investors will watch the cost line to see if Hotels can claw back its margin via cost saving and revenue growth.

While Woolworths continues to generate substantial profits, these profits are achieved on increasingly razor thin margins. Analysing key metrics such as earnings margins can help investors gain a clearer picture of the underlying business performance.

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Motley Fool contributor Tim McArthur has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.