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Meaningful (Part 2)
Starting to make sense of the numbers
General suggestions
With any financial statement, you should first look at the changes from year
to year both in the raw numbers and in the percentage changes in the
numbers. These comparisons may indicate "trends and are very helpful in
assessing a company.
It's hard to generalize about a good rate of change it depends on the line
item you're looking at and the rates of change in prior years. If a company's
sales rose 15 percent in each of the past three years and rose only 10 percent
this year, it would not be good. However, if the past years' rates of increase
had been only 5 percent, and this year's rate is 10 percent, it would be quite
good.
Vertical Analysis
Analysis of a financial statement that reveals the relationship of each statement item
to the total, which is 100%.
Most large companies include data for three years, but I recommend looking at even
longer periods of time if possible.
The financial statements represent a good starting point in judging a company's
financial strength, but they are only a starting point. To complete the picture, you
must acquire more information about the company's products, people, technology,
and other resources that may give it a competitive advantage in the marketplace. One
of the best sources of supplemental information is the non-financial section of the
annual report. This section, usually in front, often tells a lot about top management's
views on the company's future and ability to compete.
Before I talk about the statements, let me explain what I do in general as an investor.
When I buy shares of an established company public at least ten years I look at
trends for five numbers. This is the trend analysis in action. These include net
times.
HELPFUL DEFINITIONS AND CALCULATIONS
Trend
A pattern in a company's financial performance over time. For example, if a company's sales have
been increasing over many months or years, analysts would describe this pattern as a sales growth
trend.
Net sales
A company's total sales less returned merchandise and discounts. Listed on the statement of
earnings.
Net earnings
A company's total revenue less total expenses, showing what a company earned (or if lost, called
net loss) for a set period, usually one year. Listed often literally as the "bottom line" on the
statement of earnings. Also called net income and net profit.
Price earnings ratio (P/E ratio)
A ratio used to evaluate the relationship between a company's price per share and the earnings per
share (EPS). For example, if a company's stock is selling for $12 per share and the earnings per
share is $2, the P/E ratio is 6 (12 2 = 6).
Take Aim
Lets try out these ratios
2006
2005
05 vs '06
06 vs '07
Increase or
(Decline)
Increase or
(Decline)
Target
(in millions)
Walmart
(in millions)
05 vs '06
Operating Income
2007
2006
2005
Increase or
(Decline)
2005
06 vs '07
%
Increase or
(Decline)
05 vs '06
06 vs '07
Increase or
(Decline)
Increase or
(Decline)
Target
(in millions)
Walmart
(in millions)
Net Earnings
2007
2006
Target
(in millions)
Walmart
(in millions)
05 vs '06
EPS
2007
2006
2005
Increase or
(Decline)
06 vs '07
%
Increase or
(Decline)
Target
(in millions)
Microsoft
(in millions)
off the
Keep this in mind and train yourself to seek out liabilities reported indirectly as well as
directly.
Backlog
The amount of a company's unfilled orders at the end of the year. When the company fills the orders the
following year, it records the revenue on the statement of earnings. Frequently, a company will give its
perspective on backlog in the management discussion section in the annual report.
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Current ratio
Indicates the ability to pay current liabilities as they mature, providing the ratio of
current assets to current liabilities. As a general rule, a current ratio of 1.5 or greater
is normally sufficient to meet near-term operating needs. A current ratio that is too
high can suggest that a company is hoarding assets instead of using them to grow
the business -- not the worst thing in the world, but potentially something that could
impact long-term returns. You should always check a company's current ratio (as
well as any other ratio) against its main competitors in a given industry. Certain
industries have their own norms as far as which current ratios make sense and which
do not. For instance, in the auto industry a high current ratio makes a lot of sense if
a company does not want to go bankrupt during the next recession
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Debt to Equity
Indicates the balance between total equity ownership (common and preferred
stockholders) and long-term debt. The greater the percentage, the more leveraged
is the company.
Debt ratio
Indicates the balance between total equity ownership (common and preferred
stockholders) and long-term debt. The greater the percentage, the more leveraged
is the company.
Risk Management Association determined that the acceptable range for the debt ratio is 0.57 to 0.67.
Higher ratios indicate a company that is highly leverages, lower ratios indicate a more stable organization
Ready to try??????
Lets try out these ratios
Comments on the Statement of cash flows
On this statement, look at the figure for cash provided, or used, by operating
activities (operations). Without a doubt, this number is the most critical on this
statement. These activities represent the basic business of the company. If a company
consistently fails to make money at its basic business, it will have a hard time surviving.
In a healthy mature company, operating activities normally result in positive cash flows.
The other ways a company receives or spends cash investing and financing are
more difficult to interpret. For example, negative investing cash flows may indicate only
that the company is growing and buying assets that enable it to manufacture more
products. Financing cash flows are affected by a company's borrowing and the amount
paid in dividends during the year. To interpret these numbers, you need more information
on the company's strategies.
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Efficiency ratios
MIXED STATEMENT RATIOS
Collection period
Measures the number of days sales that are uncollected in average accounts
receivable, providing an idea of how successful the firm is in collecting its customer
debt.
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