Earnings reports can be reviewed and interpreted in different ways by different investors. Some prefer skipping the opening sections on financial data to read about management's take on the market and the risks facing the company. Some prefer jumping right into the numbers and comparing those to previous quarters and years. Regardless of how you look at the report, going about its review methodically will help you understand what is going on.

The first part of the document outlines what company is filing the report, for what period and tax identification information. The report will then list a table of contents indicating which sections are found on which pages.

Financial Information

You should then move on to Part I (Financial Information) and examine and analyze the financial data. Some investors go after the "buzz" items, such as revenue, net income attributable to common stockholders, diluted earnings per share and EBIT. While these are important, make sure to dig deeper.

• How did the company perform over the last quarter?
• How did the performance compare to the previous quarter, or to the same quarter in previous years?
• Have revenues improved or taken a hit?
• Is the cost of sales increasing, meaning that it is more expensive to bring in revenue?

Look over the cash flow statement to see if the company is earning cash from continuing operations or is using it. Companies might have negative cash flow but are still able to show positive net income. If things look fishy, remember that you can always walk away and not buy the stock.

Financial Risk Factors

Once you have a sense of a company's financial health, it's time to check out the risks that it might be facing in the coming quarters. If a company has outstanding lawsuits, it has to report them along with a brief description of what the lawsuits are about. The company won't necessarily attach a price tag to a particular legal problem, so you will want to examine the nature of the lawsuit. Consider the potential financial impact of the lawsuit compared to the overall value of the company. Many companies face relatively small damage claims each year, but may sometimes face a giant lawsuit that can have a major financial impact (think pharmaceuticals and big tobacco).

Consider whether the risks are part of a general market trend, such as lower sales during a recession, or if they are part of a larger problem, such as revenue coming from one or two sources rather than a diversified set of customers.

The Bottom Line

You don't have to be a big-time equities analyst to get an idea of what an earnings report is telling you. Use what you know about stocks and financial strength to determine your best course of action, and think twice before spending a lot of time using techniques employed by sophisticated investors if you won't know how to interpret the results. There are a lot of publicly traded companies posting earnings reports each quarter, so don't feel behind schedule just because you aren't reading every report. Concentrate on stocks that are of interest to you, and remember that even if the information found in the earnings report makes you not want to buy the stock, reading it was still a worthwhile activity. After all, it saved you from making a bad choice.