3.12 “Earnings Season” and the Importance of Financial Statements to the Capital Markets

Today’s stock markets are very sensitive to “earnings’ season.”  This happens every quarter when the companies release their previous quarter’s earnings.  The important numbers the market watches are, Sales Revenue and Quarterly Earnings in relation to consensus forecasts.  As discussed in the introduction to Valuation Tutor there are different models used to estimate what a stock is worth.  The simplest is called the “dividend model,” covered in Chapter 6.  This model takes the view that if you buy a stock, you are entitled to receive future dividends paid by the stock.  From this perspective a stock’s “fair value” equals the present value of the future dividends. 

Applying the above logic requires forecasting future dividends and also the rate(s) at which these will be discounted.   Future dividends are paid from future earnings which in turn depend upon future sales revenue.  As a result, stock prices depend upon both earnings’ and sales forecasts.  Forecasting the future, however, is very difficult and in an influential old book by Burton Malkiel, A Random Walk Down Wall Street, he discussed implications for stock prices from the random walk hypothesis. This hypothesis applied to the stock market introduces the controversial idea that that one cannot consistently outperform market averages.  Irrespective of ones view of this hypothesis it does serve to underscore the importance of beating the consensus forecast when observing changes in stock prices in relation to the release of additional financial statement information over time.

From a reporting perspective Valuation tutor provides access to these important quarterly statements from the 10-Q filings that define “earnings’ season” for three quarters throughout the year.  The fourth quarter is defined from the 10-K filings.  It is noted, however, that the 10-Q financial statements are unaudited and therefore it is not uncommon for earlier quarters to be revised.

Valuation Tutor provides easy access to both the quarterly financial statements (illustrated below) and current consensus  forecasts from different sources on the web.  To access this information from the main screen you use the menu item “View Filings.”

The sub-menu items let you configure the screen in different ways:

·         SEC Filing Viewers at Bottom --- this lets you bring up the interactive statements at the bottom of the main container.  You then have immediate access to both annual and quarterly interactive statements including one click exporting to Excel.

·         Information Browser at Bottom – this gives immediate access (in a web browser) to a wide range of relevant information that is available on the web including Consensus Forecasts.

·         SEC Filing Viewer on Right --- for some analysis and reconciliations it is convenient to have the three major financial statements up – Income, Balance Sheet and Cash Flow or a major statement as well as some of the supporting schedules.  This feature lets you replace the Textbook with a third supporting statement.

·         SEC Filing Viewer Popup – finally if you require even more information up simultaneously you launch pop up windows containing additional filings, companies and including access to the online textbook information

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In summary, earnings season only serves to reinforce the importance of financial statement analysis, having immediate access and the knowledge required to process lots of information that is available in today’s world.  In the next Chapter we focus upon how the building blocks introduced in this Chapter are actually applied to real world decision making and analysis.