5 Tricks Companies Use During Earnings Season

Public companies in the U.S. report their earnings every quarter to the public. They may use tactics to make sure their bottom line doesn’t disappoint. This includes knowing when to time the release, distracting investors in their communications, drawing attention to favorable information, reporting other accounting methods, and increasing share buybacks. As an investor, knowing what to look out for can help you make better decisions about your investments.

1. Strategic Release Timing

Communication teams often release bad earnings reports (or bad news) when they suspect the least number of people are watching. It wasn’t uncommon for companies to release information after the market closed on a Friday afternoon in the 1990s—sometimes on a holiday weekend or when key economic data was due for release so the spotlight was off the company.

In today’s markets, it comes down to the general timing of a release rather than a specific day of the week. A company may plan to announce its earnings after hours when fewer investors may be watching. Conversely, the numbers can be released when hundreds of other companies are reporting and markets are distracted. This minimizes any scrutiny over a bad report,

Some companies may announce a positive development when news is bad. They might announce a major new customer, large order, store opening, product launch, or new hire around the same time that bad news is released. Again, the idea is to convey the image that things aren’t that bad.

Don’t be fooled, though. Reading the small print in a company’s footnotes and the hidden news stories can help you uncover a stock’s real story.

2. Cloaking Their Communication

In the interest of full and fair disclosure, companies must disclose the good and bad information about the quarter in their earnings reports. Their communications teams may attempt to bury the bad news by using phrases and words to mask what’s going on. Language like “challenging, “pressured,” “slipping,” and “stressed” should not be taken lightly and could even be red flags.

For example, rather than announce the company’s declining gross margins and that the company’s earnings may be affected in the future, management may simply say that it “sees a great deal of pricing pressure.” Meanwhile, the investor is left to calculate gross margin percentages from the provided income statement—something that few retail investors have time to do.

It’s important to note that unfavorable information tends to be located somewhere near the bottom of the release and could be coupled with other information. For instance, some company teams may talk about all of the new products they anticipate releasing in the coming year (in the announcement) or other upbeat, forward-looking news, and then say what investors can expect in terms of earnings in the future period.

Since the earnings expectations are not a standalone item (but are bunched with other information) and the average investor may have nothing handy to compare the company’s forecasts to (such as the current consensus number), the communications team wins by burying the news and distracting the public.

3. Enhancing Preferred Information

Some investor relations teams will bold or italicize headlines and information in an earnings release that they want the investment community to focus on instead of the results. This isn’t a trick designed to fool you, but it can take advantage of reader laziness. Don’t be mesmerized by the highlighted data and be sure to read the entire release. Look for future guidance if provided, too.

Here’s a hypothetical headline you may find in a release that you shouldn’t be so consumed with: “Q3 EPS Increases 30 Percent.” Play detective and read into what management is saying and forecasting about the company’s future periods.

4. Use of Non-GAAP Measures

A company’s executive management can also cite accounting measures that aren’t aligned with generally accepted accounting principles (GAAP). Non-GAAP items are designed to strip out or add in certain items. Public companies must adhere to GAAP when compiling their financial statements.

Non-GAAP financial measures can also be included in an earnings presentation. These metrics might show a company’s revenue based on its core operations by excluding one-time costs. For example, companies may exclude the costs of their employee stock program.

Again, these measures are not deceptive, but they can show the company’s numbers in a more positive light. Examples of non-GAAP measures include earnings before interest and taxes (EBIT) and cash flow and free cash flow.

Earnings Before Interest and Taxes (EBIT)

Earnings before interest and taxes is a non-GAAP measure of earnings. A management team might highlight its growing EBIT over several quarters. But, its interest expense might be significant if the company has a lot of debt. As a result, EBIT would look far more favorable than net income, which includes interest expense in its calculation.

Cash Flow and Free Cash Flow

Cash flow and free cash flow are two popular metrics that investors, analysts, and company executives monitor closely.

Cash flow is the net amount of cash transferred in and out during a period. A company with positive cash flow has enough liquid assets that can be easily converted to cash–to cover debts and financial obligations. This figure is reported on a company’s cash flow statement and broken down into three sections; operating, investing, and financing activities.

Companies can cite positive cash flow figures during an earnings presentation. However, if the company sold an asset, it would show a positive cash entry, inflating the cash reported for the period. Selling assets is common for cash-strapped companies to meet their dividend obligations. That’s why you should examine free cash flow, which is a company’s cash flow without capital expenditures.

5. Increasing Stock Buybacks

Stock buybacks can be a good thing. Some company boards, though, may authorize one to make their stock appear more attractive to investors. You may notice that a company may announce a buyback with or just after bad news. Investors should monitor their timing to ensure that board members and executives aren’t trying to bolster the stock price during times of poor performance.

Although investors typically cheer when stock buybacks are announced, you should analyze whether the company has the cash and revenue generation to fund the repurchases.

Companies can use buybacks to inflate their earnings per share (EPS). If a company has no preferred dividends, reported earnings of $18 million, and 10 million shares outstanding, the EPS was $1.80 for the period ($18 million ÷ 10 million shares).

Now, let’s assume earnings remained flat in the next period with management deciding to buy back three million shares. The EPS would be $2.57 for the period ($18 million ÷ 7 million shares). All else being equal and without any additional profit, the company posts a higher EPS in the second period.

The Bottom Line

As an investor, you must be aware of how companies can improve their earnings and financial ratios during earnings season. Take what you read or learn with a grain of salt and learn to delve a bit deeper to see if there are any hidden messages or clues in a company’s earnings report. You may even want to develop a strategy or approach to analyze a company’s earnings and whether the company hit or missed its target.