If numbers are your thing, the annual reporting season for listed companies is not to be missed. Be they for sales, margins, profit, cash — or umpteen other variables — there’s plenty to keep any numberphile busy.

The interpretation of those numbers, though, is not always easy, but it’s very important.

‘Good’ and ‘bad’ are relative terms in investing. A 20% lift in sales is no doubt disappointing if you were expecting them to double, for example. Likewise, a halving of a company’s profit will be considered great… if forecasts were for a 90% plunge.

Moreover, the plethora of numbers provided by companies refer to the last financial year, and it is the future that matters for investors. No matter how dire things may have been last year, if things are expected to materially improve the market will most likely react by pushing shares higher. Or vice versa.

That’s why shares in both Woolworths Limited (ASX: WOW) and BHP Billiton Limited (ASX: BHP) rallied strongly after each released massive losses. And why super-strong profit growth and an all-time record profit can lead to massive price falls, as it did for Blackmores Limited (ASX: BKL) and The Reject Shop Ltd (ASX: TRS).

Even then, there’s much more to the story. The fact is, companies can be incredibly complex entities, operating in even more complex environments. The numbers contained within financial reports are invaluable, but no single metric can ever tell you the whole story. And without context, they can be almost meaningless.

Savvy investors need to adopt a holistic approach. Strong profit growth is no good if it was achieved by underinvesting in the future, or by slashing costs associated with important functions. Similarly, you might grow sales by dropping prices, but if that comes at the expense of margins, the business could well be less profitable overall — and could hamstring efforts to raise them again in the future.

Also, how have the numbers changed from previous periods? And, what’s driving that change? A cyclical (and by definition, transient) downturn could move things in the wrong direction, but still have no bearing on the underlying economics of the business and its longer-term prospects. On the other hand, if more structural forces are at play, even a small change could be a worrisome portent of (permanent) things to come.editor

Foolish takeaway

For true investors, whether or not a company delivers numbers in line with some broker’s forecast is really not that important. Financial results are reflections of real-world things, and carry important (and valuable) qualitative insights.

The art (and it really is more art than science) is to understand the narrative with that comes from the numbers. To translate the language of accounting into a clear investment thesis — one that you can neatly summarise in a page or two, in plain English.

Master that, and the (financial) world is yours.

 

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Motley Fool contributor Andrew Page 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.