Getting sucked into earnings season can sometimes leave the average investor with a major headache.
Often, a stock’s reaction to the data their company releases can seem like a complete mystery — A company beats revenue estimates, but still sells off.
Here’s one final rule for how to better interpret earnings results.
One Size (Doesn’t) Fit All
There’s no one-size-fits-all standard when it comes to understanding earnings. Beating top line estimates isn’t automatically good and earning no profit isn’t necessarily bad. Results depend on the company you’re looking at.
To effectively interpret an earnings report, it’s critical to consider what the main driver of a company’s growth is. Here’s what I mean…
Say you’re looking at a company like Walmart. For an established retailer like this, obviously revenue and earnings would be most important.
But a growth stock, on the other hand, would take a slightly different perspective. Growth stocks are companies expected to grow at a pace above the general market. Usually they’re newer companies possibly offering some breakthrough, cutting edge product.
Growth stocks are companies that are dependent on revenue growth. Now that may sound a little obvious — but there’s a subtle distinction. The revenue number is key for any growth stock. A lot of growth companies may not turn a profit for years so earnings can basically be zero or negative. But it’s not just the number.
What’s key is how much the company’s revenue grew from the previous year. A growth stock whose revenue is barely beating the previous quarter — or worse, slowing down — won’t stay in the market’s favor for long. The key to being a growth stock is to be able to generate outsized growth.
Sometimes Money Isn’t Even the Key
Take a company like Netflix. They’re the leader in the subscription video on demand (SVOD) industry.
This past January, Netflix reported earnings for Q4 of 2022. The company beat estimates where earnings went and matched the street’s best guesses on revenue. BUT… Its number of new subscribers was down from Q4 2020.
Not only that, they announced they were only expecting to add 2.5 million new subs in the first quarter of 2022. The market displayed its displeasure…
Things got worse in their next report.
While still beating analysts’ earnings estimates and matching revenue estimates, their subscriber number was a disaster. Projecting to add (a disappointingly low) 2.5 million new paying customers, they actually LOST 200,000 subscribers.
Once again, the market punished them…
For a subscription-based growth company like Netflix, revenue numbers are important, but not nearly as important as its subscriber numbers which are the driver of the company’s success. The slow down in new subscribers from Q4 2021, even though the number itself beat analysts estimates, was enough to shake up the market.
Other companies’ success can likewise hinge on non-dollar based results. Pick any social media platform. Sure, revenue is important, but not as important as their monetizable daily active users.
Obviously, if a company’s revenue or earnings numbers aren’t performing well, there better be a good, one-time reason for it. But oftentimes there are more subtle clues as to a company’s health.
To really understand that, understand the drivers behind a company’s success.
Make the trend your friend,
Editor, Streetlight Daily