Reading Financial Reports for Dummies (50 page)

financial position to shareholders and analysts

this occurred, the analysts could tell key inves-

at the same time or within a reasonable period

tors who depended on their analysis (and, by

(usually 24 hours) after the first company out-

the way, paid them big bucks for their services)

sider gets the information. This practice began

to buy or sell stocks before the general public

in 2000 after the adoption of the Fair Disclosure

even knew anything about what was happen-

Rule (Regulation FD), which mandates open ing. Individual investors could lose a major part disclosure to everyone as soon as possible of their stake in the company before they even after one person outside the company gets the

knew what was driving the stock price down.

information. The information can be something

Regulation FD killed that practice and leveled

as simple as the expected net income for the

the playing field for individual investors. Today,

quarter or something as dramatic as the deci-

individual investors must get information at the

sion to buy another company.

same time that analysts and portfolio manag-

ers for large institutions (such as pension and

Prior to the SEC rule calling for fair disclosure,

mutual funds) do.

companies often told financial analysts several

Culling Information from Analyst Calls

Today, investors get information not only by reading press releases or newspapers but also by attending company calls for analysts, which used to be open only to financial analysts and institutional investors. Companies usually sponsor these calls when they release their annual or quarterly earnings reports. But special events — such as a change in company leadership or the purchase of another business — can also prompt companies to set up analyst calls. By listening in on these calls, you usually get more details about whatever issues are being discussed.

The company CEO, president, and chief financial officer (CFO) typically participate in these calls. They usually start the call by discussing the recently released financial reports or by explaining the impact that the special event has on the company; then they usually open the call to questions.

The question-and-answer part of the call is often the most revealing, as you can judge how confident senior managers are about the financial information they’re reporting. Questions from the audience usually elicit information that press releases or the annual or quarterly reports haven’t revealed. Most times, analysts and institutional investors ask the questions; in many situations,
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individual investors don’t have an opportunity to ask questions at all, but you can still learn a lot by listening to these conversations. And don’t hesitate to write or call the company’s investor relations department to get an answer to a specific question you may have about the financial report or the special event discussed during an analyst call.

The language participants use in an analyst call is different from the language you use every day. Familiarize yourself with the most commonly used terms before listening to your first call. I list most of the key terms and abbrevia-tions used during analyst calls in Part III of this book, where I discuss analyzing the numbers. Get comfortable with terms like
earnings per share
(EPS),
EPS growth, net income, cash,
and
cash equivalents.
Check out the sidebar

“Decoding analyst-call-speak” for more on analyst-call lingo.

If you hear a term you don’t understand, write it down and research it after the call. Then the next time you listen in on one of these calls, you’ll have a better understanding of what’s being discussed.

Listening between the lines

Pay attention to how the executives handle the call and to the words they use. When management is pleased with the results, you usually hear very upbeat terms, and they talk about how positive things look for the company’s future. When management is disappointed with the numbers, they’re more apologetic, and the mood of the call is more low-key. Rather than talk about a rosy future, they’ll probably explain ways in which they can improve the disappointing results.

You most likely need to listen to more than one call hosted by a particular company before you start picking up the nuances and moods of the executives. Try attending as many of these calls as you can or listening to a recording of a call after it occurs. Many companies actually post recordings of their analyst calls on their Web sites, just like they post press releases.

Take the time to read the financial reports before the call so you’re at least familiar with the key points that management discusses during the call. After you listen to a few calls for the same company, you’ll find that the information that management discusses will become much clearer.

Earnings expectations

All calls about a company’s financial results include information about whether the firm has met its own earnings projections or the projections of financial analysts. If a company misses its own earnings projections, the mood of the call will be downbeat, and the stock price is likely to drop dramatically after the call.

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Part V: The Many Ways Companies Answer to Others

Decoding analyst-call-speak

In addition to the financial terms I use through-

the revenue charts look lumpy. If you hear

out this book, you’re likely to hear a few color-

this term, listen for explanations about why

ful descriptions when listening in on an analyst

sales were lumpy and whether this result is

call, such as the following:

normal for the company.

✓
Hockey stick:
Management may say that ✓
Run-rate:
Senior management uses the company revenue came in like a
hockey

term
run-rate
when talking about how to

stick,
meaning that most of the revenue

project a company’s current performance

occurred in the final days of the quarter. In

over a period of time. For example, if the

this situation, the revenue charts actually

current quarter’s revenue shows a $1 mil-

look like a hockey stick because they’re flat

lion monthly run-rate, you can expect the

most of the month and then shoot up in the

annual revenue to total $12 million. This type

last few days. Listen for explanations about

of projection may work for firms with steady

why sales jump up at the end of a month

earnings, but it doesn’t work for businesses

or quarter. It may be normal for the type

that have primarily seasonal products. For

of business or it may be related to some

example, if a retail company reports a run-

outside factor, such as a storm that closed

rate for the fourth quarter that includes hol-

stores for part of the month.

iday sales of $1 million per month, you can’t

✓

expect that performance to carry over for

Lumpy:
Senior management refers to

the entire year. So you must be certain that

uneven sales in a given quarter as being

you understand a company’s revenue pic-

lumpy.
During some weeks, the order rates

ture before counting on run-rate numbers.

were low, and during other weeks, the

order rates were high; these results make

That doesn’t mean you must sell the shares you own, if you happen to be a shareholder. In fact, if you’re listening to the call because you think you’d like to buy the stock, you may want to do so after the stock price is driven down by the bad news. The key for you as a shareholder or potential shareholder is to analyze what’s being said and whether you think the company has a good chance of turning around the bad news. Good news, on the other hand, can drive the stock price higher. Be careful not to jump on the bandwagon right after major good news is announced. Usually, the stock price falls back down to a more realistic price after the initial rush to buy is completed.

Revenue growth

Listen for information about the company’s revenue growth and whether it has kept pace with its earnings growth. Growth in revenue is the key to continued earnings growth in the future. During an economic slowdown, watching revenue growth becomes very important because a company can play with revenue numbers to make them look better. In fact, some companies practice what’s called
window dressing
(using accounting tricks to make a company’s financial statements look better) to make sure their earnings meet
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expectations. Earnings growth is easier to manipulate than revenue, so earnings usually become part of that window dressing. I talk more in Chapter 23

about how a company can manipulate its results.

If you hear numerous questions from the analysts about revenue-growth figures, it may be a sign that they suspect a problem with the numbers or are very disappointed with the results. When you hear analysts’ questions about revenue or any other issues over and over again, take a closer look at these numbers yourself. Do further analysis and research before you decide to buy or sell the company’s stock.

Analysts’ moods

Listen carefully to the analysts’ tone as they ask their questions. Take time to assess their moods. Do they seem downbeat? Are they asking very prob-ing questions, or are they upbeat and congratulating the executives on their performance? When analysts are disappointed with a company’s results, they dig for more information and ask for more details about the areas where they see a problem. The call’s discussion focuses on past results and how management can improve future results. When analysts are happy with the results, they encourage further discussion about future results and plans.

You may find it difficult to judge the mood of the analysts or company executives when you listen to your first call, but as you listen to more and more calls for the same company, you’ll be able to judge more easily how the mood differs from that of previous calls.

Getting the facts right

You can judge whether the executives are confident in their reporting by how quickly they answer the questions. When executives are comfortable and confident in the numbers, they answer questions quickly, without rus-tling through papers. If they’re very cautious with their answers and are constantly taking time to look through their papers, you can be sure they’re not comfortable with the report and must carefully check themselves before answering the questions.

If company executives seem unsure or respond slowly, take this as a red flag that you need to do a lot more homework before making any decisions about buying or selling that company’s stock.

Looking toward the future

Listen to the vision that the company’s executives portray for the future. Does the vision they present inspire you, or are they unclear about their vision for the company’s future and how they plan to get there? If you find the executives uninspiring, they may not be doing a good job of inspiring their employees, either. If you see a downward trend in the company, this may be one of the reasons for that trend. When executives lack inspiration for the company’s future, you have a good reason to stay away from investing in that firm.

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Part V: The Many Ways Companies Answer to Others

Employee satisfaction

Keeping employees happy is important for the future of any company. During the call, you can judge whether employees are satisfied by listening for information about the success or failure the company’s having attracting new employees or retaining existing ones. If the business reports a problem with either of these two things, trouble may be on the horizon. High employee turnover is bad for the growth of any company, and a firm that has trouble finding and recruiting qualified employees may also face a difficult future.

Don’t ever plan to buy or sell stock based only on what you hear during analyst calls. Use the calls as one more way to gather information about a stock that you’re thinking of buying or for tracking stocks that you already own.

Knowing when to expect analyst calls

To find out when a company plans to host an analyst call, check out the investor relations section of its Web site. Some companies may just post a recording of the call on their Web site. A few companies don’t even mention the calls at all; in this case, you can call the investor relations department and ask them if you can attend their analyst calls. Some firms do ban investors from analyst calls.

Some companies offer investors a service that alerts them to upcoming events. If the companies you plan to follow don’t offer these services, your best way of tracking upcoming analyst calls is through one of two Web sites: Best Calls (www.bestcalls.com) and VCall (www.vcall.com).

Staying Up to Date Using

Company Web Sites

The Internet provides an excellent way for companies to stay in touch with their investors. Companies can include an unlimited number of pages on Web sites that investors can access whenever it’s convenient for them. Because investors can print multiple copies of the information provided online for free, businesses can save the expense of providing thousands of pages of information to their investors.

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In addition to basic information — such as company headquarters, mailing address, phone numbers, and key executives — many companies post their firm’s history, market share, vision and mission statements, credit ratings, and stock dividend history. Many companies also post all the information from their annual meetings, financial reports, press releases, and key executives’

speeches, as well as allowing investors to order paper copies of previous annual and quarterly reports up to five years old. So the Internet is a handy tool that gives investors greater access to company activities and helps the firm keep its investors better informed — which improves the company’s long-term relations with its investors.