Reporting season, that eight-week period when listed companies’ fess-up’ their earnings - is just around the corner.
During this bi-annual ‘look-see,’ you should get the ‘Full Monty’ on how good, bad, or otherwise the previous six months was and what’s in store - so it’s important to pay attention.
With consensus earnings per share (EPS) growth forecasts (see table) now pointing to double digits, investors will be looking for companies to guide to strong growth this year.
This is why it’s important to look beyond the numbers and focus on the underlying commentary.
Fresh numbers that surface as reporting unfolds can and will have a significant impact on the long-term value of the stocks you own. But you need to know what to look out for, and this is where many investors can come unstuck.
One of the best ways to get a quick fix on the quality of a company’s balance sheet is to check out key performance measures. These include debt levels, cash flow ratio, net-debt to equity, EPS and return on equity (ROE) growth, and the strength of its cash flow relative to reported profits.
Here are 10 tips to help you separate the numbers and supporting commentary from the spruiking of those good news stories that often accompany reporting season.
Have an idea of what you’re expecting from a company ‘before’ it reports so that you’re in a much better position to determine whether the result was good or not.
Read the financial statement ‘before’ the supporting commentary. If there’s no mention within the commentary of certain key numbers, it’s probably not a good sign – so you’ll need to investigate.
Remember, Australian accounting standards allow for significant wriggle-room when it comes to ‘playing’ with the figures on their balance sheet.
It’s also important to understand most companies would dearly love you to focus your attention on earnings before interest and tax (EBIT), and often strip out charges deemed non-operating.
Compare how a company presented its report in years past. If numbers that used to be presented aren’t any more, it’s not a good sign.
Examine how well cash has been flowing through the business and check to see whether profits and cash flow are broadly in sync, if not - find out why.
Check to see if a company has a ‘funding gap.’ This occurs when there’s insufficient cash to continue operating and the company is forced to take on debt or raise capital from shareholders.
Generally speaking, the greater a company’s funding gap, the less likely it is to expand its business, pay (sustainable) dividends, and withstand any economic downturns.
Check whether the type of business and its level of expenditure complement the way it chooses to report to the market.
Remember, profit is an accounting number, so you need to understand what’s excluded from underlying earnings.
For example, a P/E valuation is more meaningfully applied to companies with an established history of consistent earnings that are indicative of normal cash flows the business earns.
The same is true for another ratio like net tangible assets (NTA) which is an accounting rule (not a market value). So, looking at NTA in absolute terms can be misleading, especially when to comes to listed REITs (real estate investment trusts).
Find out what management is doing for the long term good of the business.
Does the company have a history of poor disclosure and why? Be on the lookout for companies that perennially need to satisfy a ‘please-explain’ to shareholders.
Check how management is responding to its problems.
You need to check for guidance on dividend policy and pay-out ratios.
Take a close look at the balance sheet and the quality of a company’s cash flow to decipher whether a dividend looks sustainable or not, and look to the commentary for meaningful clues.
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