Equities

Equities is this week's foundation topic, covering individual stocks, corporate earnings, and how the market judges them. Since the entire issue focuses on Nike's Q4 earnings it is the perfect week to learn how to read an earnings report the way an investor does. We are going to do it in three simple checks.

Check 1: Beat or Miss, Against Expectations

A stock reacts to results measured against the bar analysts set for it, not to the raw number. So the first thing to find is whether the company cleared that bar. Nike's adjusted 20 cents beat the 13 cents analysts expected, and its $10.97 billion of revenue beat the $10.86 billion forecast. On the scoreboard, that is an obvious beat on both lines.

Check 2: The Quality of the Number

Nike's reported profit was 72 cents per share, but 52 of those cents came from a one-off tariff refund of nearly $986 million. That same refund added roughly 900 basis points to gross margin, increasing the reported figure to 49.2% while the underlying margin barely moved and stayed close to 40%. If you remove the one-off the underlying profit falls back to 20 cents. This is known as the quality of earnings, which means how much of a profit comes from the actual business versus from one time boosts. High-quality earnings are durable. Low-quality earnings, like these, inflate the numbers.

Check 3: The Forward View and the Underlying Trend

Markets care more about tomorrow than yesterday, so the last check is where things are heading. Here the picture is genuinely mixed. China sales fell 12% and Converse revenue fell around 32%. But underneath, the running business grew double digits for a fifth straight quarter. There is a real recovery in here. It is just not a finished one.

Now for a worked example, using a number that comes up in almost every investing conversation, the price-to-earnings ratio, or P/E. It's the share price divided by earnings per share, usually the last 12 months of actual profit. Analysts often use next year's expected profit instead, which is exactly what UBS did here. Either way, it tells you how many dollars investors are paying for each dollar of profit.

Even after falling roughly 43% to around $41, Nike is not obviously cheap by this measure. Analysts at UBS pointed out it still trades at roughly 27 times next year's expected earnings. Paying 27 times earnings isn't exactly a steal. The market is basically assuming the company's turnaround is already a done deal. It just goes to show that a stock can sink and still be overpriced if people are still expecting too much from it.

The main takeaway: A headline "beat" tells you almost nothing on its own. The real skill is finding the one-offs and then checking the underlying number against expectations and the road ahead.