The announcement of a companies earnings is much anticipated for several reasons. Firstly, it shows how the company has performed in its given business. Secondly it is possible to see how the company is performing as compared to other businesses and the economy generally. From this information, investors make decisions regarding future buying or selling of the companies shares.

Following company earnings announcements from the more high profile companies in Australia, the newspapers will generally be full of comments from analysts on their interpretation of the results.  While it may be very useful to hear these interpretations, what is more useful is if you understand how to interpret the results yourself.  This will help you ensure that the company’s current performance and future objectives, or aligned with your own investment objectives. 

Price earnings ratio

One of the most popular ways of comparing companies is by using a ratio called the Price to Earnings ratio or P/E’s. This is found by dividing today’s price by the last current earnings and shows the number of times the price covers the earnings. Investors commonly use this ratio to measure the attractiveness of particular shares and to compare shares in one company with those in another. Put another way, how long will it take the earnings to cover the price paid for the shares.

As an example, if a share cost $10 and the earnings are $1 per year, it will take ten years of earnings to pay back the price of the share. This is a P/E of 10. Investors use this to compare businesses, assuming that earnings are the live blood of a business and the P/E is the pulse rate.

Earnings guidance

Nearly every earnings announcement will be broken into two parts; what has been and what will be. The earnings season is also the time that management of companies comment on the future outlook of their business and the economy in general. These announcements have been called earnings guidance, and are as important as the actual earnings of the company. This is because people who buy shares, or choose to hold them, do so not because of what earnings were in the past but what they are likely to be in the future. This is also the time management announce major changes to business plans and key staff.

Companies listed on ASX are required to adhere to a regime of ‘continuous disclosure’ whereby they must immediately announce to the market any events that are likely to have a material effect on their share price.  There are some exceptions to this rule but generally, earnings season can sometimes be as much about setting the scene for the next period, as it is the results of the past. Investor can get a better understanding of how a company plans to operate for the coming year and the environment it will be operating in. The purpose of the whole event is to inform share holders and investors, helping them make better investment choices.

More information

ASX offers a number of classes that cover analysis of a company's annual report, in particular the Tracking your sharemarket investment and Analysing and selecting shares classes.  These classes are available free online, please visit the ASX website for more information.

ASX is interested in your thoughts, please email any comments or feedback on this article.