An earnings announcement is the public statement a company offers to reveal its profitability for a certain period of time. Most often, an earnings announcement details profit for a quarter or a year.
Well before an earnings announcement is made, equity analysts study past announcements and other metrics to develop earnings estimates, speculating on what the earnings announcement figures will be for the company. Investors and traders also often study the company’s metrics to speculate on the company’s profitability. Speculations by analysts often lead to the movement of the company’s share price, up or down, depending on the estimated profitability.
Once the earnings announcement is made, the company’s share price will move even more significantly, going up if profitability is high and going down if profitability falls short of the speculated or estimated figure.
An earnings announcement is a public statement a company makes revealing its profitability for a certain period of time, usually quarterly or yearly.
Equity analysts use several tactics to create estimates of a company’s profitability, including the DCF model, the MD&A of the company’s previous financial statements, and consideration of external factors.
Earnings announcements are important because they are definitive proof of a company’s profitability for the given period of time.
Developing Estimates with the Discounted Cash Flow Model
Analyst’s estimates play a critical role in how a company’s stock performs in the days leading up to and immediately following an earnings announcement. But how do they develop the estimates?
The goal is to determine the value of a company’s future earnings per share (EPS). An analyst will use a variety of fundamental factors to calculate estimates, often relying heavily on management guidance and forecasting models to do so.
One of the most popular forecasting models that analysts use is the discounted cash flow model, otherwise referred to as DCF. Using DCF analysis, analysts determine the present value of cash flows that are expected in the future; a discount rate must be determined to complete the calculation.
DCF is useful for investors because it allows them to determine if the present value of their investment is going to be profitable. Determining the expected future cash flows shows whether the anticipated future flow is equal to or greater than the present value of an investment. In terms of a company and its earnings announcement, the investment would be shares in the company.
Other Factors for Analysts Estimating a Company’s Profitability
Analysts also often use factors a company lists in the management discussion and analysis (MD&A) portion of its financial reports. The information is crucial for estimations because it allows analysts to see a broad overview of the company’s operations and financial performance for the previous quarter or year.
Growth or decline in different areas of the financial statements can be examined and dissected – the income statement, balance sheet, and cash flow statement. The MD&A portion of previous earnings announcements plays a critical role in helping analysts develop their estimates because it highlights what helped drive growth for the company, as well as the risks that the company is facing.
The MD&A can also reveal if the company is facing any legal issues that can result in lower share prices in the future. Legal issues essentially equal a potential scandal that could negatively affect consumer opinion and drive share prices down.
In addition to financial models and financial statements, analysts also look at the external factors that may affect a company. It includes:
Industry trends (including mergers or bankruptcies in the same industry)
Importance of Earnings Announcements
Earnings announcements can be likened to the grand marshal ushering in the earnings season parade. It is the first undisputed proof that analysts, investors, and traders receive regarding a company’s performance for the quarter or the year.
The days before an earnings announcement are important for investors and analysts to pay attention to. It is when analysts speculate and provide estimates that result in a definitive effect on share prices, either causing them to start an upward or downward trend. The day of the earnings announcement, however, is of primary importance.
If the announcement is the same as the analysts’ estimates or is better than the estimates, the company’s share price is likely to climb. The better the earnings announcement, the higher the share price will rise.
CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below: