The more experienced investor

This is the second in a multi-part series aimed at building your knowledge if you have at least some experience of investing. Look out for the next part in the series in a future issue of Shares.

What can you do in five minutes? Spend a penny, have a smoke, pop round the shops for a pint of milk, but what about analysing a company’s financial results? Think, no? Think again.

Warren Buffett has famously invited anyone wanting to sell him a company to make a proposal – and says he will be able to give an indication of his interest within five minutes. To be clear, investment decisions should not be made too quickly. Investors need to really understand the relative pros and cons of a company before they invest, its strengths, weaknesses, threats, and opportunities.

But zooming in on key parts of a results announcement and coming to a rough conclusion is a skill that financial journalists have relied on for years. And it can be equally valuable for retail investors, especially those with reasonable experience who already know their way around a P&L (profit and loss account, or income statement), balance sheet, cash flow statement, and importantly, the notes at the end, which often reveal an awful lot of detail that simply sticking with the headline numbers would miss.

For those in need of a company accounts reminder, this feature in Shares from February 2021 might be useful.

WHY YOU SHOULDN’T BEGIN AT THE START

Surprisingly, we do not recommend starting at the beginning, but with the cash flow statement. Once you are familiar with this statement, it is simple to understand and, importantly, it is the hardest of the three for management to manipulate.

The cash flow statement helps you work out free cash flow. This is an important calculation, because it tells you how much of the cash generated by the company is available to shareholders.

This statement also tells you how much cash has been spent on capital expenditure and paid out as dividends, how much has been allocated to debt repayment, and how much has been raised from the issue of new shares. It will also show depreciation and amortisation charges, and any share-based payments. Some investors prefer to exclude goodwill amortisation and share-based payments from profits.

All this information fleshes out the story.

Let us look at a real example, holidays company On the Beach (OTB), which reported full year results to 30 September 2022 on 8 December 2022.

ASSESSING GROWTH

Next, we would turn to the income statement, where growth in the business can be assessed, both growth in revenues and growth in core costs. The P&L can be a surprisingly inscrutable financial statement, particularly when littered with ‘exceptional items,’ which are often negatives including asset such as write-downs, for example.

That said, it is important to skim through revenues and costs line by line, which will help you calculate margins; gross, operating and net. If revenues are flat while costs are rising, it means margins are declining, and you will want to know why (see table next page).

Turning to the balance sheet, here’s where you calculate the net debt-to-equity ratio and other measures of financial health. Have these ratios improved or deteriorated, and why? What has happened to intangibles, and why? Is inventory piling up? Running your eye down the balance sheet, line by line, is a useful exercise that can quickly flag up issues for further investigation.

Developing the discipline of looking at the three main financial statements first can be a useful way to draw conclusions before reading management commentary. They may adjust metrics to paint the business in a more flattering light and focus on the positives. Nevertheless, reading the company’s line on what has happened in the relevant period is important to get a feel for how well or poorly management has handled problems.

FOUNDATION FOR FAST ANALYSIS

Expectations matter and novice investors are often surprised when a company announces decent looking growth and profits, yet the share price falls. This, of course, happens usually because of forecasts, and whether the reported numbers have missed, met or beat them.

This means that knowing what the market is expecting beforehand is useful, and it is worth your time getting a steer on forecasts ahead of an announcement if possible. Forewarned is forearmed, as they say. Several websites and platforms offer full year forecasts for UK companies, such SharePad or Stockopedia for example, but you will be expected to pay for access to these services.

And you will seldom find forecasts for half-year or quarterly periods available, which can make assessing in how the figures match to market expectations tricky. With US stocks it is typically easier, particularly for larger companies among the S&P 500, say.

Quarterly earnings and revenue forecasts can be found on websites like www.investing.com, for example. And if you use Twitter, following a source like @ConsensusGurus will be helpful – it tweets regularly reported versus expected figures for better-known US companies.

Finally, you will want to spin through the company’s outlook statement where you can get a feel for management’s underlying confidence. Management optimism, or lack thereof, can have a significant impact on the share price, as can reputations for under-promising, over-delivering (good!) or over-promising, under-delivering (bad!).

With experience, you should be able to separate sensible from spin.

‹ Previous2023-03-02Next ›