’Tis the season! But not the one that involves giving gifts and carol singing. It’s corporate Australia’s earnings season, where accountants get to take the centre stage.
In February and August each year, most companies listed on the Australian Securities Exchange (ASX) have to report their half-yearly performance in detail.
This might seem like quite a dull affair, but for the world of finance, it’s a blockbuster event. Investors watch on with bated breath, and company share prices can move dramatically with the announcements.
And it has big implications for the rest of us, too. Here’s why earnings season is so important, and how to make sense of all the noise.
Companies get a ‘report card’ twice a year
Earnings season is also called “profit season” or “reporting season”.
It falls at the same time each year because ASX-listed companies are all required to report their earnings within two months of the end of their half-yearly reporting periods – typically January to June, and July to December.
An earnings report is like a school report card for a company and its management. It provides key financial information about half-yearly performance, such as revenue, profit, earnings per share, and a range of other metrics.
Together, these provide important insights into a company’s performance and financial health.
What are the key figures?
Let’s look at three of the metrics investors and analysts pay the most attention to in a company report. They can help assess whether a company is growing, stagnating, or declining.
Net profit after tax – “NPAT”
This figure is a company’s “bottom line” – income minus expenses. It adds up all the different sources of revenue for a company, and deducts all the different expenses incurred, including taxes and interest.
Earnings before interest and taxes – “EBIT”
EBIT is still a measure of profit, but in contrast to NPAT, it excludes interest and tax payments from a firm’s calculated expenses.
Why leave these things out? Put simply, EBIT can give a sense of whether a firm is making good business investment decisions, regardless of how it is taxed or how it is financing capital.
Earnings per share – “EPS”
EPS is calculated by dividing a company’s NPAT by the number of common shares on issue. This indicates how much of a company’s profit can be attributed to each share.
It’s all about expectations
Earnings season is an important opportunity for the market to assess whether companies are meeting or beating its expectations – or else failing to deliver.
Like a school report card, there are consequences for these “grades”, particularly if they turn out to be different to what the market expects. They can lead to significant activity and short-term volatility in the share market, with consequences for individual companies’ share prices. Let’s look at some examples from this month.
On August 14, the Australian medical imaging company Pro Medicus reported a higher-than-expected full-year net profit of A$82.8 million, up 36.5% on the year before. Its share price closed the day 7.2% higher.
The next day, Cochlear, a well-known hearing implant company, also reported an increase in net profit, up 19%. But its share price fell by 7% after the announcement.
Why would a company’s share price fall when its earnings go up? The key here is expectations.
A company’s current share price factors in all the publicly available information about that company and its expected ongoing performance.
If an increase in earnings is still less than what the market expected, as we saw with Cochlear, its share price may go down.
Conversely, if an earnings decrease is less than expected, or forecast losses are not as bad as anticipated, a company’s share price may go up.
These daily share price movements when earnings are announced can be extremely large, but not unusual. In comparison, benchmark average annual share returns are typically around 10%.
It matters for the economy
It might still seem like high finance, but the consequences of these earnings announcements go well beyond the specific companies involved and interested investors.
Australia has a relatively small share market, dominated by some major players. The performance of these major companies during earnings season can often tell us something about broader economic trends, just as we use changes in gross domestic product (GDP) and inflation as economic indicators.
Strong earnings performance across key industries could suggest a healthy economy, while poor earnings could indicate economic trouble.
Last week, for example, electronics retailer JB Hi-Fi announced stronger-than-expected sales, which was interpreted by the market as a suggestion weak consumer demand may be coming to an end more broadly.
Earnings reporting season can also provide some insights into industry specific trends.
For example, if multiple tech companies all reported strong earnings in the same period, market participants would quickly try to work out potential causes of overall industry growth – in this case, perhaps increased uptake of artificial intelligence and related technologies.
It matters to the rest of us, too
Beyond any immediate concerns for the economy, nearly all of us have a further vested interest in the performance of these companies.
Whether we follow the market or not, our growing superannuation “nest eggs” are tethered to its performance. For those of us still in our working years, long-term performance matters more, but nobody wants to see a market downturn as they enter retirement.
Whether you follow the share market on a second-by-second basis or not, what happens in earnings season will affect you.
This article is part of The Conversation’s “Business Basics” series where we ask experts to discuss key concepts in business, economics and finance.
Michael J. Davern, Professor of Accounting & Business Information Systems, The University of Melbourne and Matt Pinnuck, Professor of Financial Accounting, The University of Melbourne
This article is republished from The Conversation under a Creative Commons license. Read the original article.
