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Scanning the financial results

February 6, 2008
Remember
Revenue is the same as sales; income and earnings are the same as profits

Quick tip
Get the current stock price from a newspaper. Divide it by the earnings to get EPS. This is one (but not the only or most important) ratio used to evaluate a stock

It's that time of the year when quarterly reports flood mailboxes and newspapers. Chances are that you'll ignore them. But with the markets resembling a yo-yo, and everyone saying it's a good time to buy, these reports may help you pick up a good stock. Company reports are easily accessible online.

All you really need to know is what to look for. There is lots in a company report to understand if the company stock is a good buy. We identify some basic numbers for the beginners, across three main sections of a report.

1. Profit and loss account

This is not the company balance sheet. As the name suggests, it tells you how much profit or loss the company has made in the given time period with a summary of it's revenues, costs and expenses.

Total revenues
Indicates the growth possibilities of the company. Check year-on-year growth for at least three years to assess consistency of performance

Operating income
Tells you what the company earned from its main business. Considered a true indicator of long-term profitability. In specific instances and periods, a company can have high "other incomes"

Net income
Also called the bottom line, net income should be rising faster than the sales growth

2. Cash flows

Cash flow indicates a company's financial strength. It tells you how much cash came into the company, where it came from, how much was used and for what. The greater the amount of free cash, the greater the company's chances to expand, pay dividends, repay debt or buy-back stocks.

Cash flow from operating activities
Should be positive. Some high-growth companies tend to show negative figures in the early years

Cash flow from investing activities
Typically negative. Implies that the company is reinvesting in its business. If a company does not reinvest in its business, it may artificially show higher cash inflow in the current year, which may not be sustainable for the business's long-term health

Cash flow from financing activities
All cash inflows and outflows from issuances, repayments, stock buy-backs, or shareholder dividend payments are reflected here. A large fraction of the funds for company's expansion comes through this route

3. Balance sheet

Tells you what the company owns, what it owes and shareholder's equity. It's called a balance sheet because assets and liabilities must even out

Accounts receivable
Indicates the company's ability to meet its financial obligations and remain profitable

Inventory
If inventories grow faster than sales, it is a negative factor

Total liabilities
Shouldn't be too high or too low. High debt increases risk level, while too low debt restricts its ability to grow. You should generally be able to find out exactly which liabilities are accounted for by reading the attached foot or end notes

Keep in mind

Words like "write-offs", "charge-offs" and "one-time charge" generally mean that the money was spent on something that is no longer useful

Always read the footnotes to financial statements. Much of the truth about a company's health is buried here

Compare the results with companies in the same industry

Neither balance sheet nor profit and loss account or cash flow is better than the other. All three should be understood to get a complete picture of a company's finances


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