Some Tips on Fundamental Analysis and Properly Reading Financial Statements. - Copied from blog

Hi everyone, this is my first post and I am new to reddit so constructive feedback would be nice and such.

A little bit about myself is that I am a finance student and an active investor in the stock market; with finance also comes some knowledge of understanding accounting. I got bored today and have been reading a lot of posts on reddit and found that there is not many in-depth attempts on fundamental analysis other than vague discussion on certain sectors and their potential for the future.

But maybe that’s because people don’t know enough regarding fundamental analysis itself and/or don’t have enough time to learn it?

Fundamental analysis is not only observations on the sector and what the company has done/wants to do, but its also how well-equipped is the company able to achieve not only its own expectations, but Wall Street’s expectations? How has the company performed in the past quarters and how will they LIKELY perform in the following quarter(s)?

Large dips in the stock price from prior months obviously signify a lacking investor sentiment, but practicing actually going over what made the stock drop will make you a better investor. Don’t just read the articles! Go to the earnings report and/or the conference call, did they report less revenue than expected? Did they not beat EPS? Did they cut their outlook?

There is a lot of information that many people do not know in terms of reading financial statements and one glance at it can often turn people away since they can be somewhat difficult to read.

So I thought that I would make a short, little mini-guide and provide some general tips and info on how to read them and what to look for!

  • Pick a company and follow along with the post!(If you’re a business mjr student, you probably already know all this)

First, Look At The Balance Sheet.

This is usually the deal-breakers for many potential investors.Covering all of the balances will take too long, so I’ll go over some basic and important ones

ASSETS:

  • Consider how much on-hand cash do they have (Cash and cash equivalents)
  • Accounts receivables? (Money that they are expecting to come in sometime soon)
  • Inventories (value of their merchandise)
  • Goodwill (this arises when companies acquire another company and its the value of their intangible assets, think of patents, the value of the brand name, etc)
  • Intangible assets (patents, trademarks, etc, they are all essentially non-physical assets to the company)

I don’t generally consider/look at (gross property, plant) but these include land, buildings and equipment etc; they decrease in value per year but again I would not really stress these over too much.

LIABILITIES:

LIABILITIES ARE EXTREMELY IMPORTANT

Again, I’ll cover some basic important balances:

  • Accounts payable (short term dues that need to be paid off to vendors/creditors)
  • Accrued liabilities (similar to accounts payable, these are expenses that need to be paid off but have not been officially logged)
  • Long Term debt (debts that are not owed within the next 12 months, can include long-term loans, bonds, notes, etc.)
  • Deferred revenue (this is revenue that the company receives in advance from customers or other companies, but the service itself has not yet been provided)

COMPARE HOW MUCH LIABILITIES THEY HAVE COMPARED TO THE ASSETS In many articles, the amount of liabilities and debt that they have are often discussed, this was and is ESPECIALLY important with the emergence of Canadian marijuana companies last year; look at ACB (they’re drowning in debt with not much cash).

Check if they are paying off their debt or are incurring more.

Debt is not necessarily bad so long as its sustainable and not burdening (it shows that the company is growing)

If you are looking at banks and credit card companies (AXP, Visa, etc.) looking at doubtful accounts or bad debts expense is especially helpful, but you can check it for any company; these essentially show the amount the company lost to customers unable to pay their dues; these can be potentially dangerous if their customers have a worrying history of being unable to pay.

Income Statement.

This covers the revenues and expenses of the company and their net income! A lot of the general ones are self-explanatory so I’ll cover the main ones

  • Total Revenue (Revenue without the costs)
  • Cost of Revenue (can also be referred to as “cost of goods sold,” how much money it took to generate said profit. Example: The box sold for $5 but it costed $3 to acquire/produce)
  • Gross Profit (Total revenue-Cost of Revenue. THIS IS DIFFERENT FROM NET INCOME!)
  • Operating Income (This is income after operational expenses)
  • Net income (the difference between this and operating income is that it weighs in factors such as interest expense, income taxes, etc. THIS IS THE BOTTOM LINE PROFIT AFTER EVERYTHANG)

Of course there are many balances of expenses but they are self-explanatory as you look at them.

Observe the net income, is it positive or negative? Is it rising or falling?If the company is not yet profitable, potentially how close is it to profitability?

Unprofitable companies should not necessarily be written off just for the sake of being unprofitable, just look at what happened with Tesla; you can also say the same with Uber and how they now forecast profitability by the end of this year- there is lots of renewed interest in the company despite being unprofitable.

Risk Factors

These are located in the 10k financials and also quarterly earnings financials (I am unsure if the 10k has more cited risk factors). Not only do they show the risk and potential problems the company may face but reading them can also give you some insight on how the industry works and whether or not it is seasonal.

Example: Risk factor for Yeti- They have mainly two manufacturers. These two manufacturers produce over 80% of all their products.

We can conclude that if one of these manufacturers were to run into some problems then the supply chain would be drastically affected.

Management/Proxy Statement

Lastly, we have management whom of which is crucial for steering the direction the companies are moving in. For this, you have some options, you can either look up the upper management’s backgrounds online or you could go to the proxy statemen t.

The proxy statement shows the amount of stock the CEO and the other senior officers have as well as their backgrounds/experience; a CEO that is strapped to their company through equity/stocks/options is good in that they have plenty to lose if the company doesn’t do well, this will give them more incentive to perform well.

FIN

That is pretty much all I have, I was considering whether to cover calculations for EPS, PE ratio, stock dividends, market cap, ROA (return on asset/investment) etc. but I feel that this post is already dense and I dunno if people will actually find it helpful so I’ll end it there. Obviously, there is waaaaaaaay more to cover but if this helps at least one person, then coolio! GOOD LUCK AND HOPEFULLY YALL MAKE THAT $$MULAA$$

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Rookie. Calling financial analysis fundamental analysis. We are not accountants. Tell him to stop looking in the past. Investing is about the future.

Good Summary. Some thoughts.
Financial Statements are the report card of the past. There is no guarantee of repeat in future.

Still, two thing must clearly stand out from the Financial Reports:

Debt and Cash Flows ( where is cash coming from : is it from operations, or borrowing, or investing)

Apple was a dead company in 1990s. But, it is one of the most valued company today. So,a company with bad past can turn out to be money minting machine in future. And reverse can also happen

If you use financial analysis, you won’t invest in AAPL or sell very early. Dumb.

I just trust Steve Jobs, period.

When SJ returns, no matter how you look at it, Apple can’t prosper in the shadow of WinTel dominated world. You have to trust him to come up with something.

After few years of iPods, you would realize that product would last long. You have to trust Steve Jobs to bring out something else.

Great leaders and corporate culture would ensure the long term survival and prosperity. These are not captured in financial analysis.

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Financial Statements still tell you about the debt. It cannot be easily be wiped of unless the company is taken to bankruptcy. Microsoft was an investor in apple and sold it by 2003, I guess. But, the real gain in AAPL came after 2003.

I have stated that already that Financial Statements are backward looking. It is like looking at Bill Gate grades who dropped out and then think he cannot do well as a CEO or entrerpeneur.

I think Steve Jobs was not even an engineer.

He is an ex-HP engineer.

Did he have a 4 year college degree in engineering?

Degree = No.

Thought you mean work as an engineer.

Genius no need degree. Mediocre needs one.

Please tell this to parents who kill there children demanding straight A++++ in all subjects. And extra curricular, and all that.

SJ forced BG to put $ in AAPL to settle the copying of MacOS.

They knew. Geniuses are rare. The more your children don’t have winning personality, the more such accolades they need. Simple and brutal truth.

How to spot a company like AAPL and then not sell early? I think this is the question every one wants an answer for.

TSLA is pretty close.

I missed TSLA boat. What to pick next? How often companies like this come in market?

I’m not sure I agree. Steve Jobs was quick to make Apple financially stable while it was on the brink of bankruptcy. The change in trajectory was shown through financials as they quickly went from losing money to profits. If he hadn’t change that, they’d never have lived long enough for iPod.

Apple is the rare case of a company innovating across multiple generations of tech. Just look at the dominant PC companies and early cell phone companies. They got killed by newer innovation. Most companies only last as long as their founding tech is innovative, and they miss the market move to new tech.

Also, Apple had high gross margins. That was an indicator of the profit potential. It also had relatively low R&D spend from focusing on so few products. That gave it way better P&L leverage which led to the massive profits.

Some tech companies spend 50% of revenue in sales and are getting g zero leverage in it. If sales increase 40%, sales expense increase 40%. Those companies aren’t going to make the leap to high profitable.

Are you referring to the early part where he slashed revenue from $11B to $7B, from loss of $1B to profit of $500M? Stemming the bleeding and stabilized the company, allowing Apple the breathing space to develop the iPod. Note: My numbers are off my head, could be wrong, still illustrative. However, the long term viability is not sure yet then, just unlikely to go bankrupt. Many investors bought when he returned and sold after that. I recalled the P/E is pretty high, 60-100 range.

This is the part where corporate culture works its magic. AFAIK, that is what SJ wanted to create and he had instituted an Apple university to teach all levels of management of that culture. Should Apple lasts more than 100 years, that would be his greatest product.

I believe it has since increased after the death of SJ. Anyhoo, its corporate culture ensures there is no runaway R&D expenses. Small sum to investigate, bet big when reasonably sure.

:+1:

Good point. But, for those who do not have time and skills (which is most of us),
Debt and Cash flows tell the story. So any investor must at the minimum be aware of these two things about a company. IF cash flow is growing, is debt also growing? Or is company selling the family silver to raise cash? Or the company has a strong product offering that brings the cash. Ideally, we want to see cash come from operations (by selling company products and services).

Exactly. He had to stabilize the financial situation to survive long enough to design new products. Once financially stability was achieved it was a much less risky investment even though success was far from assured.

R&D has increased a lot, and it’s been a topic of debate. What is Apple doing with all of that R&D? People are expecting more new products.

Facebook is a great example. When it went public, it tanked. The big threat was mobile, because Facebook had almost no mobile revenue. They focused on mobile and within a year a majority of their revenue was from mobile. That was a turning point, and it was obvious from the financial results. The stock is up about 8x since then.

How to make sense out of EPS of a company when it is compared with the Industry Average EPS? If a company issues more stocks, naturally its EPS will be smaller as compared with EPS of a company that issues fewer stocks for same income and same market cap. Or is there anything I am missing in this story?

It’s not useful to compare EPS across companies. It’s like comparing price per share across companies. You should compare P/E ratio across companies.

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