Interpreting earnings reports Step 1: Understanding how the company makes money

When analyzing a company's earnings reports, what should we look at first?

Earnings per share (EPS)? Free cash flow? Or return on equity (roe)?

These financial indicators are all important indeed.

However, before delving into these numbers, let's first see if this company is worth spending a lot of time researching.

How can we find out?

The answer lies in the business model.

The business model refers to how a company makes money through what avenues or methods.

For example, supermarkets make money by selling daily necessities, while banks make money by providing loans.

There are many ways to make money, such as direct sales, franchising, and physical stores, which are some traditional business models.

There are also diversified business models, such as the combination of e-commerce and physical stores.

For investors, it is important to understand different business models.

Firstly, understanding business models can help us make smarter investment decisions.

The famous value investor, Warren Buffett, once said he only invests in businesses he understands.

Secondly, understanding business models can help us better interpret financial data.

For example, when comparing profitability indicators, different business models can have significant differences.

Companies like Microsoft and other technology firms generally have higher profit margins than retailers like Walmart.

However, this does not mean that Microsoft's business model is more successful than Walmart's.

If you want to deeply understand a company's business model, how can you do it?

In fact, there are two places in the annual reports of US stock companies that can help us better understand the company's business.

They are respectively, item 1 'Business of the Company' and item 7 'Discussion and Analysis by Management of Financial Condition and Results of Operations'.

What products the company sells and where it operates its business can be found here.

We take Apple Inc. as an example.

By reading item 1, we can know that Apple Inc. is a company that makes money by selling hardware and services.

These hardware include iPhone, Mac, iPad, AirPods, Apple TV, and so on.

The services include advertising, cloud computing services, digital content, and payment services, and so on.

In section 7, Apple divides its revenue by business and region.

This allows investors to better understand the various businesses and the revenue brought by each region to the company, as well as the growth situation.

In addition, sections 1 and 7 also provide information on the company's recent situation, market competition, and other information to help investors have a further understanding of the company's operations.

Now, I believe you have a certain understanding of the company's business model.

If you are not interested in the company's operations, you may consider researching another company.

If you think the company's operations have growth potential, you can continue to research the company's financial situation.

The best place to research the company's financial situation is the three major statements: the income statement, the balance sheet, and the cash flow statement.

In the upcoming courses, we will start with the income statement.