With earnings season in full swing, investors may be wondering how to interpret their company's earnings results.
While it can be tempting to gauge this based on the share price reaction, this isn't always accurate.
Instead, here are four indicators investors can monitor to determine whether their ASX investment has delivered a strong result or disappointed.
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Track record
Investors will often compare a company's result to its history.
Growth companies with a track record of high revenue or profit growth will be expected to continue performing. This is also built into the share price. Any deviation from this could see the share price decline substantially.
For example, Pro Medicus Ltd (ASX: PME) has been able to grow revenue at a compound annual growth rate (CAGR) of around 28% over the long term. If Pro Medicus were to report revenue growth closer to 15%, this would not be well received by investors. Despite 15% revenue growth being an objectively solid number, it is below that which is expected of Pro Medicus.
It is the expectation that Pro Medicus will continue this track record that allows it to continue trading at a very high price-to-earnings ratio (P/E) multiple. Any deviation from this would likely result in significant multiple compression.
Before a result is released this earnings season, it can be useful to determine the company's historical revenue and profit growth trends to set a benchmark.
Management guidance and commentary
Management credibility is often regarded as a qualitative investment criteria. Investors want to be able to trust what the managers of their investment are saying.
Companies that consistently exceed their guidance are often well-regarded. For example, Supply Network Ltd (ASX: SNL) has a history of setting three-year targets and consistently meeting them ahead of schedule.
Before a result is released, it can be useful to listen to previous earnings calls. This allows investors to judge whether management has delivered on its promises or moved the goalposts.
Sector and wider economy
All investments are relative, and certain sectors can be more cyclical than others. For example, the mining sector is notoriously cyclical, whereas the consumer staples sector is relatively consistent.
It can be useful to develop a general understanding of how the relevant sector and wider economy are performing.
For example, in a challenging retail environment, flat same-store sales may be a good outcome for a company if its peers have all reported negative sales growth.
Personal criteria
Finally, it's important to maintain perspective about why investors made the investment in the first place.
For example, investors may be targeting a certain level of passive income to fund their retirement. When they first invested, the dividend yield may have been an attractive 5%. However, the company may have cut or paused the dividend. This may mean the investment is no longer suitable for their needs.
Alternatively, the company may have merged with another company or expanded into a business line or market that the investor doesn't understand. This may make it challenging for an investor to monitor performance going forward. It may also be another sign to exit the investment and find something more suitable.
Of course, this final criteria will be different for everyone.
Foolish Takeaway
As earnings season picks up, investors may be wondering how to gauge the earnings results of their investments. Instead of relying on the share price, consider how the company has performed in the past, whether management has delivered on its promises, the wider sector and economy, and whether the investment is still suitable for the individual investor.
