My essential checklist on how to interpret companies' profit reports

With so many companies reporting how should an investor interpret their profit reports?

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August is a busy time of the year for stock market investors. This is because August 31 is the deadline for most publicly listed companies on the ASX to release their full-year financial results.

Due to this deadline, retail investors are bombarded with "market-sensitive announcements" through their brokerage platform, from companies that they are invested in.

This can be an exciting but also stressful period for investors. For example blue-chip favourites like Woodside Petroleum Limited (ASX: WPL), Insurance Australia Group Ltd (ASX: IAG) and Commonwealth Bank of Australia (ASX: CBA) reported recently.

While institutions have the luxury of employees who's full-time job is to pour through the pages of information issued by companies, retail investors, who may work a full-time job, do not have this luxury.

If you are a busy, time-constrained retail investor, then have no fear.

As we approach the second half of August, where the majority of companies will report, you can still stay on top of your investments. Below I've put together a quick checklist that in 15-20 mins that will cut through all the noise in the company reports and focus on what's really important:

1. Did they beat or miss management guidance/consensus earnings?

  • Most retail investors won't have access to what is known in the industry as "consensus earnings estimates". This is when you pay for a service that combines the "sell-side" analyst coverage of companies, to produce an average earnings prediction for the upcoming result. If however, you do have access to a service like this, make sure you jot down the consensus earnings estimates for the companies in your portfolio before they report.
  • Most retail investors won't have an expensive subscription to sell-side analyst coverage, and will have to rely on management guidance as a proxy for consensus earnings. In the lead up to your company's results, make sure you look back on previous market updates to get the latest management earnings guidance. Management usually give guidance on important metrics such as revenue, net profit after tax (NPAT), earnings per share (EPS), earnings before interest depreciation and amortisation (EBITDA) etc.
  • Once the company you are interested in releases its report, compare the actual numbers to the ones management guided for or the consensus estimates. This will give you an instant read on the performance of the company. Usually an "earnings beat" is followed by an increasing share price and an "earnings miss" a falling share price. This is not an exact science though.

2. If they missed, why?

  • Time to dive a bit deeper into the report. Look for explanations from management as to why they did not deliver on the guided numbers. Here you should be analysing management's justification and trying to put the company into one of two baskets:

1. It missed due to deteriorating structural/long-term conditions of the business or the industry it operates in.

· If this is the case it is usually best to sell your shares because the value of the firm is likely to continue to decrease with time.

2. It missed due to short-term factors that do not have a long-term effect on the value of the firm.

· Examples for this basket are contract-timing issues, one-off regulation or weather events, increased investment due to strong growth opportunities etc.

· This is the basket that can provide some excellent buying opportunities for the long-term focused investor. Many share prices will fall after a short-term earnings miss, as institutional money that has a short-term mandate, flows out of the company.

3. Forward outlook statements

  • Sometimes a company will give some quantitative insight on how the first few months of trading in the new financial year have been going by releasing some key financial metrics. Other times it might be just a short qualitative description of trading conditions.
  • If you have followed the company for a while you may have an idea on management's tendency to be either conservative or overly optimistic. Keep this in mind.
  • Pay close attention to any outlook statements, the underlying tone, and management's track record of delivering on guidance. This may provide important hints on the future performance of the company and a good investment depends more on the future financial returns of the company than the past.
Motley Fool contributor Jacob Ballard owns shares of Woodside Petroleum Ltd. The Motley Fool Australia owns shares of Insurance Australia Group Limited. 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 Scott Phillips.

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