stock-earnings-quality-review

name

stock-earnings-quality-review

description

Review a US-listed company's earnings quality, cash-flow integrity, and operating leverage for an equity-research workup. Covers operating cash flow vs net income drift, free cash flow trajectory, capex character (maintenance vs expansion), equity issuance / shareholder-return yield, revenue-quality signals (receivables vs revenue growth, channel stuffing), gross-margin level and trend, operating leverage, and three-cost-rate hygiene (S&M, R&D, G&A). SaaS-specific: ARR/NRR/GRR/CAC payback/Magic Number. Trigger when analyzing financial statements at L1+L2+L3 of the seven-layer X-ray framework. Dispatched by stock-analysis-lead.

Stock Earnings Quality Review

Purpose

Read the income statement, cash-flow statement, and selected MD&A passages with the eye of an analyst who trusts cash over accruals. Surface the most common quality red flags: net income that doesn't convert to cash, capex understated as "maintenance" while it's really expansion, receivables ballooning faster than revenue, gross margins eroding under cover of revenue growth, operating leverage that runs in reverse. Output a structured Findings set; do NOT draw the verdict — orchestrator does that.

When To Use

• Orchestrator dispatches earnings-quality review (always-on in Standard / Strict depth).
• User asks about "earnings quality", "is the profit real", "cash conversion", "operating leverage", "margin trend".
• A pre-cursor to valuation — you cannot trust forward earnings until you've tested the quality of trailing earnings.

When NOT To Use

• Balance sheet leverage / liquidity / goodwill → stock-balance-sheet-review
• Business model / customer concentration → stock-business-review
• Management capital allocation → stock-management-review
• Competitive moat / market share → stock-industry-review
• DCF, multiples, target price → orchestrator's synthesis step

Mandatory Gates

1) Execution Integrity Gate

You must read the cash flow statement from the most recent 10-K and the latest 10-Q. If neither is in the manifest, return SKIPPED (no cash flow data).

2) Multi-Period Gate

A single quarter or single year is noise. Compare ≥3 years of annual data (10-K plus historicals from manifest's financial-history.json if present). Trend matters more than level.

3) Sector-Aware Gate

A 20% gross margin is normal for retail and catastrophic for software. Identify the sector from the business-review's classification (or from 10-K SIC code in the manifest) before scoring margin levels.

4) Non-GAAP Discipline Gate

Where the company reports both GAAP and non-GAAP, always check the reconciliation. If SBC, restructuring, or amortization is excluded from "Adjusted EBITDA", surface it — these are real costs.

5) First-Hand Data + Bridge Gate (mandatory)

Every reported financial figure you cite MUST come from the manifest's first-hand financials.json (SEC EDGAR XBRL, produced by scripts/finlib/edgar.py) or directly from the filing — never from a search snippet or an aggregator summary. If a figure is only available second-hand, tag it second-hand and lower the confidence of any conclusion resting on it.

• Segment → consolidated bridge required. An operating-leverage / margin conclusion is not credible without showing the bridge: segment operating income → consolidated operating income → EBIT → FCF, reconciled to the filing. If financials.json["gaps"] lists segment_operating_income (EDGAR exposes it dimensionally, not flatly), read the 10-K segment footnote directly to build the bridge — do not infer segment economics from consolidated totals.

6) Single-Period Gate (mandatory)

A single quarter's YoY is polluted by one-off items, SBC vesting cadence, and depreciation-recognition timing. Any operating-leverage or trend conclusion requires ≥4 quarters or a TTM basis — a single-quarter "OpInc grew faster than revenue, so leverage is positive" claim will be FAILed by the orchestrator's 口径 lint gate (scripts/finlib/lint.py, period_count >= 4). Strengthens Gate 2.

Workflow

1. Load first-hand financials.json (EDGAR XBRL) + cash flow statement (10-K Item 8), income statement, and segment footnote.
2. Run filing-pattern-gated scan over the checklist; semantic-confirm hits.
3. Compute trends from ≥4 quarters / multi-year series: OCF/Net Income ratio, FCF (and the GAAP-vs-adjusted gap), gross margin, opex rates, capex/D&A. Build the segment→consolidated bridge.
4. If business model = SaaS / subscription, run the SaaS sub-checklist (items EQ-06 + EQ-07).
5. Emit Findings with severity + numerical evidence (don't say "margin declining" without a number), each citing its financials.json source tag.

Filing-Pattern-Gated Execution Protocol

Execution Order

1. Identify the target sections in the manifest: cash flow statement, income statement, Note "Disaggregation of revenue", Item 7 MD&A.
2. For each checklist item with a documented filing-section pattern, locate the section and extract the numerical series.
3. HIT → quantitative analysis (compute ratio, trend, YoY change) + semantic check.
4. MISS → mark NOT FOUND; do not infer from analyst summaries.
5. For semantic items (e.g., management's explanation in MD&A): full reasoning on the passage.
6. Report only items where the numbers actually violate the rubric.
7. Include Filing pre-scan: X/Y items hit, Z confirmed as findings.

Earnings Quality Checklist (15 Items)

ID	Item	Filing Section	Threshold / Trigger
EQ-01	OCF vs Net Income drift	Cash flow statement vs Income statement	Flag if OCF / Net Income < 0.7 for 2+ years
EQ-02	FCF trajectory (FCF = OCF − Capex)	Cash flow statement	Flag if FCF negative AND not improving YoY
EQ-03	Capex character (maintenance ≈ depreciation, expansion >> depreciation)	Cash flow "Capex" vs Income "D&A"	Flag if Capex / D&A > 2× without explicit expansion narrative
EQ-04	Equity issuance pattern (dilution)	Cash flow "Issuance of common stock" + share-count history	Flag if shares outstanding grew > 5% YoY without M&A
EQ-05	Shareholder return yield = (buybacks + dividends) / market cap	Cash flow "Repurchase of common stock" + "Dividends paid"	Informational — context for capital allocation worker
EQ-06	SaaS metric: NRR (Net Revenue Retention)	Earnings releases, investor presentations	Flag if NRR < 110% for a "growth" SaaS; < 100% = customer flight
EQ-07	SaaS metric: CAC payback / Magic Number	Investor presentations	Flag if Magic Number < 0.75 (deteriorating unit economics)
EQ-08	Deferred-revenue growth vs revenue growth	Balance sheet "Contract liabilities" YoY	Flag if deferred growth < revenue growth by > 5pp (future slowdown signal)
EQ-09	Receivables growth vs revenue growth (channel stuffing)	Balance sheet "AR" YoY vs Income revenue YoY	Flag if AR growth > revenue growth by > 10pp
EQ-10	Gross-margin level vs sector + trend	Income statement; sector benchmark	Sector-aware threshold; flag declining margin > 2pp YoY
EQ-11	Operating leverage check	OpInc growth vs Revenue growth	Flag if OpInc growth < Revenue growth in 2+ recent quarters (negative leverage)
EQ-12	Sales & Marketing rate trend	Income segment	Flag if S&M / Revenue rising while revenue growth slowing (CAC inflation)
EQ-13	R&D rate + SBC treatment in non-GAAP	Income + non-GAAP reconciliation	Flag if SBC > 15% of revenue AND excluded from Adjusted EBITDA
EQ-14	One-time-item frequency (restructuring, write-downs)	Income statement "Special items" 5-year count	Flag if "one-time" items appear in 3+ of last 5 years (i.e., they're recurring)
EQ-15	Segment margin & mix-shift	Segment footnote: operating income + revenue BY segment	Flag if a segment growing >5pp faster/slower than core carries a structurally different margin AND the blended-margin trend is mix-driven, not efficiency-driven

Severity Rubric

• High: A Finding that would flip a Good-Company score item to FAIL — e.g., OCF / NI persistently below 0.7; FCF negative and worsening; NRR < 100%.
• Medium: A Finding that warrants reducing Bull-scenario probability — e.g., gross margin trending down 2pp/yr; S&M rate rising while growth slowing.
• Low: Useful context — e.g., shareholder return yield is 4%, providing a floor.

Evidence Rules

• Findings must include the numerical value AND the direction/trend. "Margin declining" without numbers is rejected.
• Cite the filing line ("Cash flow statement line 'Purchases of property and equipment'") plus the year(s) compared.
• For SaaS metrics not in the 10-K, cite the earnings release or investor presentation explicitly.

Output Format

Findings

[High|Medium|Low] Short Title

• ID: EQ-NN
• Citation: filing section + period
• Evidence: numerical value(s) + trend
• Implication: what this changes about the investment thesis

Suppressed Items

Items checked but not confirmed — list with one-line reason.

Execution Status

Filings reviewed: 10-K (FY2024), 10-Q (Q3 2025), 10-year history (stockanalysis.com)
Filing pre-scan: 13/14 items hit, 5 confirmed as findings
Skipped items: EQ-06, EQ-07 (non-SaaS business model — SaaS metrics N/A)
Sector: <e.g., enterprise software>

Summary

One line: N High / M Medium / K Low — most material: <EQ-NN short title>.

No-Finding Case

No earnings-quality findings — cash conversion clean, margins stable, leverage positive.
Notable positives: OCF/NI = 1.05 (3-year avg); FCF margin 28% and stable.

Load References Selectively

• references/earnings-quality-patterns.md — load when interpreting OCF/NI gaps, capex classification, SaaS-specific metrics, or segment-margin mix-shift (EQ-15); contains worked examples, sector-specific margin benchmarks, the Magic Number / CAC-payback formulae, and the blended-margin mix-shift decomposition.

Review Discipline

You are the most-loaded worker (15 checks). Discipline: numbers in every Finding; suppress items you cannot quantify. Orchestrator weights High-severity items heavily — false High findings damage the verdict more than missed Medium findings.