How to Read an Earnings Report: Beats, Misses and Guidance

Four times a year, public companies report their results, and stocks can move 10% or more overnight. Headlines say a company “beat” or “missed” — but beat what, exactly? And why does a stock sometimes fall after a beat? Here is a guide.

What is in the report

U.S. public companies file quarterly reports (Form 10-Q) and an annual report (Form 10-K) with the Securities and Exchange Commission. Most also issue an earnings press release — often filed as an exhibit to a Form 8-K — and hold a conference call with analysts the same day. The press release has the numbers most people trade on:

• Revenue (sales): the total amount customers paid.
• Earnings per share (EPS): net profit divided by the number of shares.
• Margins: gross, operating and net profit as a percentage of revenue.
• Guidance: the company’s own forecast for the next quarter or year, if it gives one.

“Beat” and “miss”: compared with what?

Analysts who cover a company publish estimates for its revenue and EPS. Data providers average these into a consensus estimate. A company “beats” when its actual numbers exceed the consensus and “misses” when they fall short.

Two subtleties:

1. Companies manage expectations. Many firms guide analysts toward numbers they are confident of exceeding. In a typical quarter, a large majority of S&P 500 companies beat EPS estimates. So a small beat is ordinary; investors often have a higher unofficial bar, the “whisper number”.
2. Revenue is harder to manage than EPS. Earnings can be lifted by cost cuts, lower taxes or share buybacks. Revenue shows whether demand is growing, so a revenue miss alongside an EPS beat is often read negatively.

GAAP vs. adjusted earnings

Reports usually show two versions of profit:

• GAAP earnings, following U.S. Generally Accepted Accounting Principles.
• Adjusted (non-GAAP) earnings, which exclude items management considers unusual — restructuring costs, acquisition charges, stock-based compensation, and so on.

Adjusted figures can be informative, but they are chosen by management. The SEC requires companies to reconcile non-GAAP measures with the closest GAAP measure, so look for that table. If “one-time” charges appear every year, they are not one-time. Stock-based compensation is a real cost to shareholders, because it dilutes them.

Note that consensus estimates are usually built on the adjusted basis, so headlines about beats and misses usually refer to adjusted EPS.

Guidance moves stocks more than results

The reported quarter is already over. Stock prices reflect expectations about the future, so the most important part of a report is often guidance. A company can beat estimates for the quarter and still fall 15% if it lowers its forecast for the year. Conversely, a weak quarter with strong guidance can send a stock higher.

Listen for the numbers in the outlook and for what management says on the call about demand, pricing, orders and costs. Changes in tone between one call and the next can matter as much as the figures.

Other things worth checking

• Cash flow. Profits are an accounting measure; operating cash flow and free cash flow show the cash the business actually generated. Persistent gaps between earnings and cash flow deserve a closer look.
• Share count. Is EPS growing because profits are growing, or because buybacks are shrinking the share count?
• Segment results. For companies with several businesses, the total can hide one division accelerating and another shrinking.
• Year-over-year comparisons. Many businesses are seasonal, so compare a quarter with the same quarter a year earlier rather than with the previous quarter.

A five-question checklist

1. Did revenue beat or miss consensus, and is it growing?
2. Did adjusted EPS beat, and how does it compare with GAAP EPS?
3. Did the company raise, maintain or cut guidance?
4. What happened to margins and free cash flow?
5. What changed in management’s tone on the call?

With these questions, the next “Company beats, shares fall” headline will make sense: the market was trading on question 3.