How to identify potential concerns in a company's earnings report
There's no perfect way to identify red flags in a company's earnings report, and it's important to evaluate any concerning information in the context of industry conditions, the macroeconomic environment, and other factors.
Having said that, here are a few things to watch out for:
- Slowing earnings growth.
- Missed guidance (revenue or earnings).
- Reduced guidance.
- Margin compression that isn't for some valid reason.
GAAP vs Non-GAAP earnings
You'll often see companies report two different earnings figures. GAAP earnings (also known as "net income" is the company's main earnings metric and is standardized among all companies. GAAP stands for "generally accepted accounting practices."
Many companies will also report adjusted earnings, which, as the name suggests, adjust for one-time items and non-cash charges. Stock-based compensation is one example of an expense that is reflected in GAAP earnings but not in adjusted earnings. The idea is that adjusted earnings give a more accurate picture of the company's actual bottom-line profitability (although non-cash charges like stock-based compensation are certainly important to know.