It pays to be well-versed in financial lingo, pun unintended.
If you watch CNBC or read any financial publications, you’ve probably come across earnings projections. You may have also heard terms like “beat the street”. But how do analysts actually determine how much they believe a company will earn?
Analysts come up with earnings estimates through in-depth looks into a company’s financials. When you look at any given company, it’s impossible to effectively guess how much it will earn without doing some serious homework. Let’s take the example of your own life to begin. You would start with the basics, such as your income and your tax rates. Then you’d likely continue over all of your expenses and determine what should be left over when all is said and done. If you’re moving apartments, this may become more difficult, but you’d still have to go through the same process and consider your new expenses, and any expenses associated with moving. You’d probably get a less accurate estimate if you were moving, which makes sense as it’s harder to determine what your expenses will look like. Analysts perform similar but more complicated analyses on companies.
An analyst looking at a restaurant chain will digest all the information the chain can provide. The first thing the analyst needs to determine is how much will be sold and for how much. How much does each meal cost the customer? How many meals will be sold? Basically, volume multiplied by price is equal to revenue. That being said, you can’t always predict sudden changes. Analysts need to take everything into account and to do so they’ll contact company management, read the company’s reports, survey customers, study broader industry trends, and much more.
Next, you need to do the same thing to determine gross profit. Gross profit is equal to a companies revenue minus the cost of all goods sold. To determine this, an analyst has even more research to do. They’ll talk to and/or survey suppliers, consider international trade, and of course, much more. Once you determine this, you must consider operating costs, operating profits, taxes, and interest. Once you determine the costs, you’ve arrived at the net income. Net income is earnings, so this is where the analyst’s job ends. Of course, analysis can only prove so useful, so sometimes companies beat the street (surpass Wall Street’s estimates), and sometimes they fall short.
