By Michael McCarthy

There are two company reporting seasons in Australia each year, in February and August. Around 190 of the top 200 companies will report in the space of three weeks, producing an avalanche of information. Despite the high volume, its important investors hear what the market is saying – not just for the stocks they hold, but for the wider picture of the economy reporting season delivers. Yearly and semi-annual reporting gives investors a snapshot of their company at the reporting date. The health, or otherwise, of a company is laid bare. Investors who know what to look for can glean information that keeps them in a stock, or moves them to sell. What are the key measures investors should look for in a company report?

Profits

The surest predictor of a rising share price is increasing earnings. If estimates of earnings are going up, so too normally are the shares. So the first take on any company report is the profit line. Is the company making money? Did it make more or less than last year? At what rate are profits growing? It’s also important to understand why a company is generating more or less profit. Is it due to one-off cost-cutting, or are sales up?

Free Cash Flow

Free cash flow (FCF) is a good indicator of what’s really occurring in a business. There is no right or wrong to FCF. Sometimes a business should be investing, at others, it should be generating cash. A look at the FCF can determine if the management story is matched by the business operations. Strong free cash flow is a positive sign, but may also mean the business is maturing and/or is lacking in investment opportunities.

Other important measures

The goods on hand a company holds should vary over the cycle, but the changes in inventory from one semi or annual report to the next can illustrate what’s going on at the operational level of the company. Once again, a change in the level of inventories is not in itself a positive or a negative. Understanding why inventory levels are changing informs investors.

A company’s receivables speak not only to the health of the company, but also to the state of its customers. The shares on issue determine the slice of the pie each investor receives. Any changes via buyback or issue to company officers or external parties change the calculation for each shareholder, and any significant changes should be fully explained. The dividend also requires examination. Is it increasing or decreasing? Why? Finally, investors should examine any outlook statements from the Chair and CEO. These are the experts in their respective industries. While experts are not always right, their views on what are the most important issues and how they may pan out are useful to investors in forming a view.

Telstra – Thursday, August 10

Expectations for Telstra’s report are muted, with a modest lift in profit and no change in dividend policy expected. Despite a number of exciting initiatives, the sheer size of Telstra’s operations mean it is unlikely to announce any measures that will change what is essentially a utility earnings profile.

As the NBN hits more urban areas, it appears likely Telstra will leak internet and fixed line customers to competitors. Recent growth projects in business units such as mobile are positive, but unlikely to offset this major potential drag on revenue.

Although the telco sector is hot with merger and acquisition activity, Telstra as the giant in the sector is unlikely to acquire any other companies of size due to competition issues, and it is too large for anyone else to buy. This could see it sit on the sidelines while the other industry participants play musical chairs.

In other words, there is no obvious catalyst for an up move. And Telstra is sitting near the top of its recent trading range:

This may represent a selling opportunity for Telstra, ahead of Thursday’s result. A negative catalyst cannot be ruled out, especially if Telstra were to ramp up capital expenditure to deal with its diminishing growth profile. Investors who sell ahead of the result are well-positioned for any fall towards the bottom of the range around $5.13.