While most news covers sports and politics in a largely intuitive language that caters to a wide audience, stock market news is typically delivered to a more educated, affluent demographic that is assumed to be well-versed in investing jargon – even more so in updates reporting the quarterly and annual successes of a publicly- traded company.
In order to get a better understanding of what you read, we’ll briefly explore the terms you commonly encounter in market news – specifically when a company announces its earnings. This article will illustrate where you will see these words, what they mean, and what they pose for a company, using excerpts from an earnings news report covering a fictional company, Hemlock Incorporated.Earnings Announcement
Hemlock Incorporated announced its fiscal 2016 Q2 results after the markets closed, reporting non-GAAP earnings per share of 67 cents, an increase of 17% from last quarter, coupled with a net incomeof $250 million, up from $235 million. Earnings guidance from Hemlock Incorporated fell within range, with EBITDA, net income from continuing operations, andfree cash flow beyond the high-end of their respective guidance ranges.
Highlights from the second quarter of 2016 include:
Cash and cash equivalents of $128 million.
EBITDA increase of 19% from Q1.
Free cash flow of $35 million, up from Q1’s $32.7 million
Total debt increased from $95 million to $100 million.
However, despite the 17% EPS gain, Hemlock Incorporated missed well below the analyst earnings estimate of 71 cents. Coupled with Hemlock’s increasing total debt, some analysts are left questioning the company’s ability to service its debt moving forward.4 Common Terms
Net income in its most basic definition refers to a company’s total earnings or profit. Simply put, net income is the difference calculated when subtracting all expenses (including tax expenses) from revenue. When a company’s net income increases, it’s normally a result of either revenue increasing or expenses being slashed. It goes without saying that an increase in net income is generally perceived as a positive thing and factors into a stock’s performance.
Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) is calculated by subtracting operating expenses from revenue and adding back depreciation and amortization to operating profit (aka EBIT). EBITDA can be used as a proxy for free cash flow (FCF) because it accounts for the non-cash expenses of depreciation and amortization.
On the income statement, EBITDA is a line item above net income that excludes other non-operating expenses, as well as interest expenses and taxes. Some could argue that compared to net income EBITDA paints a rawer image of profitability. While some proponents of EBITDA argue that it’s a less complicated look at a company’s financial health, many critics state that it oversimplifies earnings, which can create misleading values and measurements of company profitability. As a new investor, it’s important to know the distinction between like measurements because the market allows firms to advertise their numbers in ways not otherwise regulated.
For instance, often companies will publicize their numbers using either GAAP or non-GAAP measures. GAAP, or Generally Accepted Accounting Principles, outlines rules and conventions for reporting financial information. It is a means to standardize financial statements and ensure consistency in reporting.
When a company publicizes their earnings and includes non-GAAP figures, it means they want to provide investors an arguably more accurate depiction of the company’s health, like removing one-time items to smooth out earnings. However, the further away a company deviates from GAAP standards, the more room is allocated for some creative accounting and manipulation (like in the case of EBITDA). When looking at a company publishing non-GAAP numbers, new investors should be careful of these pro-forma statements, as they may differ greatly than what GAAP deems acceptable.
Finally, EPS is one of the most common things brought up during an earnings announcement and provides investors insight into a company’s earnings health and often affects its stock price after an announcement. EPS is calculated by taking net income, subtracting the preferred dividends (for the sake of simplicity, let’s assume Hemlock Incorporated doesn’t offer dividends on preferred shares), and taking that difference and dividing it by the average number of outstanding shares.
In the case of Hemlock, its current quarterly EPS is calculated by dividing its NI of $250 million by the company’s 37 million outstanding shares. When reported, EPS is typically compared up against EPS from either the previous quarter or year-after-year. It is also used in basic valuation calculations like the P/E Ratio.Cash in Hand, Money in the Bank