Investing basics: 5 things to look for this reporting season
February is once again upon us and Australian listed companies are reporting their half-year results. We've tapped one of Morningstar's equity analysts for the top five things he looks for when reviewing results.
February is once again upon us and Australian listed companies are reporting their half-year results.
This is an exciting time to be an investor as companies release fresh financial accounts to the market. It gives you an opportunity to look under the hood of the companies you invest in. It’s also a great time to search for bargains.
However, the deluge of information can be overwhelming. Throughout the season, more than 200 companies will release mammoth reports on their performance and outlook.
As a shareholder, it's crucial to keep up to date with a company's financial health to help you evaluate its ability to perform in the future. Results also give you the chance to revisit your investing objectives and assess a stock's suitability in your portfolio.
We've tapped Morningstar associate equity and credit research analyst Shaun Ler for the top five things he looks out for when reviewing a company's half-year results.
Over the month, the equities research and editorial team at Morningstar will also be here to help you through the daily information dump with the latest news as it rolls in and timely analysis.
Income statement: compare profit, revenue and expenses
Each reporting season, companies release a profit and loss statement – also known as an income statement – alongside their balance sheet and cash-flow statement. This document is a statement of the company's financial performance – how the company earns money (revenues) and what costs it has (expenses), resulting in an overall net profit or loss.
Ler says shareholders should ensure they seek out the income statement and compare the revenue, expenses and profits figures against previous years' results and long-term trends.
He also recommends shareholders compare the company's figures against the company's guidance (the company's prediction of its own near-term profit or loss) and market consensus (analysts' expectations of a company's performance, combined). Did the company meet expectations?
However, Ler warns shareholders to treat these estimates with caution. "If a company doesn't beat expectations and the stock price falls, don't panic," he says. "It doesn't mean it's a bad company to own. As long-term investors, if the company has good fundamentals then it could be a buying opportunity."
"On the flip side, if a stock beats expectations, it doesn't necessarily mean it's a good long-term investment. The stock could get very expensive in spite of poor fundamentals.
"At Morningstar we tell investors to focus on the fundamentals and identifying undervalued stocks."
A dividend is a payment made by a corporation to its shareholders, with each share receiving an equal amount of value. Dividends can be paid in additional shares of stock (stock dividends or stock splits). However, the vast majority of dividends are regular cash dividends, paid at predictable intervals — usually twice a year in Australia. Dividends are everywhere: 90 per cent of the companies in the ASX 200 Index make regular distributions of cash to shareholders.
While dividends are important, Ler encourages investors to look even deeper.
"Shareholders should check to see whether or not the company has sufficient dividend coverage – meaning whether or not their earnings can cover their dividend," he says.
"Because if a company doesn't have earnings to pay dividends, then a company will typically: take on debt (incurs additional interest costs), issue equity (which dilutes your ownership in the company) or sell assets (even assets good assets for a short-term gain)."
Management's strategy and long-term plans
Alongside the release of financial results, the chairman, chief executive and management will provide details of their strategy and future plans. While each company differs, companies typically issue a chairman and chief executive's message, strategy notes, material risks and outlook, and directors report and reviews.
Ler says it's crucial to pay attention to management and director's commentary about their operations to get a true understanding about what's happing in the business.
He advises shareholders to search for management's future planning, especially over the longer term in the business and strategy section of the report.
Ler says the way in which in management express their results – and themselves – in their
reports is also key. The “tone” of what they say can give investors great insight into future performance, beyond the numbers.
"If management's tone is only very positive, this might be a sign that we should look deep into the financial accounts to see if they're sugar coating things," he says. "We want to see management talking about all aspects of the business – the good, the bad and the ugly."
With experience, Ler says investors can start to track management's tone and strategy year to year and develop an ability to sense when someone is conveying half-truths.
One of the industry's best kept secrets are analyst calls in which a company’s financial results are discussed. An earnings call is a conference call between company management, analysts, investors, and at times, the media, after the results are released. Analysts may ask questions during the call of management. Most companies will then provide a phone recording or presentation of the earnings call on their website or the ASX.
Ler says analyst calls can be a gold mine for investors as management may discuss things they don't disclose in the annual report such as company-specific metrics that are non-accounting standards.