What to expect in the reporting season

ANALYSTS believe the August full-year profit reporting season will mark the low point of the earnings rout, suggesting now could be the right time to start looking at cyclical stocks again. As companies prepare for what is tipped to be the worst reporting season in 20 years, most equity strategist are forecasting that earnings will hold up in fiscal 2010. For the 1510 listed companies with a June 30 balance date -- 72 per cent of all the companies listed on the Australian Securities Exchange -- reporting season has already begun and will conclude on August 28. Almost all of the companies will post their full-year reports during August.

From The Australian

It's good to be 3?

We're in reporting season at the moment, so lots of stories about companies' financial results. Here's one from 3 - note in particular how the company refers not only to various accounting measures: total loss, revenue, EBIT, but also non-financial numbers (like total customers and churn rate). It's how you analyse all of these factors that impact on your forecasts for such a company going forward.

EPS targets

EPS (Earnings per share) is a commonly cited performance measure. Trouble is, it doesn't tell us that much. Recently, CSL Ltd effectively tripled its earnings per share by undertaking a 3 for 1 share split. Nothing about the future performance (cash flow or overall earnings) changed. Paul Kerin points out how managers focused on increasing EPS can do two bad things: (1) undertake investments when they shouldn't, and (2) not undertake investments when they should. So, what's a better measure? Kerin argues that we should focus on "cash and strategic logic". If you're looking for an overall performance measure, then Return on Equity (ROE) or Return on Assets (ROA) are going to be better than EPS, or EPS growth.

Is cash flow king?

Liu, Nissim and Thomas have recently published a paper in the Financial Analysts Journal, (Vol. 63, No. 2, pp. 56-65, 2007 to be exact) that shows that earnings does a better job than cash flow of explaining share prices. Here's the abstract of the paper:

Contrary to the common perception that operating cash flows are better than accounting earnings at explaining equity valuations, recent studies suggest that valuations derived from industry multiples based on reported earnings are closer to traded prices than those based on reported operating cash flows. The question addressed in the article is whether the balance tilts in favor of cash flows when the following are considered: (1) forecasts rather than reported numbers, (2) dividends rather than operating cash flows, (3) individual industries rather than all industries combined, and (4) companies in non-U.S. markets. In all cases studied, earnings dominated operating cash flows and dividends.

This is of course what we would expect. If (accrual-based) earnings didn't do a better job of explaining value (and summarising business performance generally), then we'd see accrual accounting disappear.

Note: UNSW students should be able to access the Financial Analysts Journal through Sirius at the UNSW Library webpage. [It's at the bottom left of the linked page].