Why investors keenly track company’s earnings

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If you closely track the share market, then you would have noticed that after the company’s earnings are released there is movement in the company’s share price. In fact, listed companies release their earnings results on a quarterly basis. These results give investors an idea about the financial position of a company, which is also used to look at a future situation of a company.

Earnings always have a substantial impact on stock prices. Take, for instance, a news headline such as “Infosys stock price hits 16-month low as IT stocks slump due to margin pressure.”

On the other hand, good earnings will have a positive impact on a company’s stock prices. A news like this will positively impact on stock prices of HDFC stocks: “HDFC Q2 PAT rises by 18% year-on-year to beats estimates.”

If investors look at current and previous quarterly results then they can analyze whether a company’s fundamentals, like its profitability and debt-to-asset ratio, are deteriorating or improving.

If a company’s earnings indicate a declining tendency, investor interest will fade; on the other hand, if earnings are expected or are positive, the investors are more positive about the company’s stocks. Further, investors are more likely to put money into a company that shows progress in its fundamentals as compared to past.

During an earnings announcement, the company provides details on the following operational activities:

• How much revenue has been earned by the company?

• How has the organisation handled its expenses?

• How much did the organisation pay in taxes and interest?

• What is the growth of sales and profit?

• What is the growth projection of sales and profit in coming quarters?

Now let us see how to analyze the quality of earning. Whether the earnings are sustainable (recurring in nature) or due to a one-off event. A company that earns a significant proportion of its total revenues from its regular business operations as against any extraordinary income or one-time gains is preferred.

Also look at the company’s earnings growth. Whether the company makes efficient capital allocation decisions which in turn create returns for the capital providers in the form of higher earnings and lead to maximization of value for the shareholders of the company.

Also, look at whether the company’s earnings are sufficient or not. Now we will tell you how to assess that. Check whether the Return on Equity and Return on Capital employed is greater than the cost of capital and the company can generate higher returns for the investors.

Munjal Mehta, CFA, Business Head, Fortune Wealth and Financial Services says “Investors need to track the company’s EPS or Earnings per share, its growth as per management commentary, and how it has delivered in the last five years. Based on that, investors can make an assessment of the valuation of the company. Consistent Earnings growth is always a big positive compared to volatile or cyclical Earnings”

One more important thing is, for different companies and sectors, other factors also play an imports role. Like weakness in the rupee can have a positive impact on export-oriented companies, hike in repo rate by RBI can impact earnings of banks. In such cases it is important that to consult market experts.