5 Elements To Look For In A Tech Company's Earnings Report
It happens every quarter. A promising, high-profile tech company reports better than expected results that beat analysts’ consensus on the top and bottom lines, but the stock price plunges as if the company has disappointed greatly. The massive amount of data that becomes available instantly triggers an incredible number of analyses, comparisons, and calculations by investors, reporters and analysts trying to determine what the results mean for the company and the share price.
As in everything in life, analyzing an earnings report is not a case of black or white; there is no right or wrong. Each investor pays more attention to the ratios, trends, figures and measurements that impact his or her investment thesis on the investment horizon that is relevant to them. A one-time fine might be significant for an investor with a short-term horizon while entering a new geography or expanding R&D activity might be significant for a long-term investor, and negative to irrelevant to a short-time investor.
Even though every company has its unique characteristics and focus areas, there are five elements that every investor should look for when reading an earnings report of a tech company:
Actual revenue and EPS figures vs. consensus: This is probably the first thing to do when looking at an earnings report. Comparing the actual quarterly/annual revenues and the diluted non-GAAP EPS to the analysts’ consensus (as aggregated by Thomson Reuters, Bloomberg, etc.) gives all investors a high-level understanding of how the company performed during the relevant period. Even though this is just one piece of the puzzle, it is significant for the initial reaction, and many investors gives it more weight in the overall analysis.
Year-over-year performance: Comparing the revenues and EPS figures to the consensus gives investors a good understanding of whether the company meets the market’s expectations. However, putting the revenues and EPS figures in historical perspective allows investors to see the bigger picture. A YoY comparison (and in some cases a QoQ comparison) enables investors to spot any discrepancies from a particular trend, significant changes, and the magnitude of the results.
Profitability: In the tech sector, profitability is not as straightforward as in other sectors. Young emerging companies might have a very impressive top-line growth rate coupled with a worsening bottom line loss that drives investors to prefer EBITDA or Adj. EBITDA figures to assess the profitability and the path to break-even. In most cases, investors should look into the profitability figures in both dollar and percentage terms. A company that beats the revenues expectations and presents a phenomenal YoY growth rate, its real story can be revealed by looking at the gross margin and EBITDA/Adj. EBITDA margin.
Guidance: As many other things in the finance and investments industry, the investors need to analyze the earnings reports to refine their investment thesis and to try to estimate how the company (and the stock) will perform in the future. Analysts and most investors determine their investment decisions, based on their own valuation models, that utilize their assumptions and expectations. However, the company’s guidance for the next quarter or next year helps to either frame a model range or act as an additional scenario in a valuation model. Anyway, the company knows itself better than any investor or analyst, and when it provides some additional information to the market, it is worth using. In many cases, companies take a very conservative approach and provide a guideline that will be easy to beat and even proceed it to the next level.
FCF and OpEx/Rev: Many tech companies, usually the smaller ones, spend more than they generate in revenues or assets. This is not necessarily a bad indicator of the business but a regular effort to grow and expand the business. Checking the company’s free cash flow and the operating-expenses-to-revenue ratio can shed more light on the company’s status, how it prefers to spend its money, and what the historical trend can tell. An increasing FCF trend is, of course, a positive indicator; however, I would then look at how the company is spending its money (R&D, S&M, G&A) in terms of revenue.
This post shortly discusses only five elements to consider when analyzing an earnings report. However, there are many more elements to cover when each investor chooses its metrics to use according to its assumptions, investment horizon, investment type, and other subjective factors. The most important thing is to use all of the available information released in an earnings report (and the following conference call) to analyze the company’s performance according to the investor’s specific criteria before making any adjustments to the valuation model and investment thesis.
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