Reading Financial Statements: Rev, EPS, Debt

Intro

Learning how to analyze the fundamentals of a stock starts with evaluating a company's financial performance & financial health through financial statements and other health indicators. Fundamentals are crucial for identifying top-tier companies.

Financial Statements  📊​

• Income statement
• Balance Sheet
• Cash Flow statement

1| Income Statement

The income statement provides a detailed report on a company's financial performance within a period of time.

• Pure Revenue growth is such a strong signal of market dominance that investors will often overlook other weaknesses in favor of a company consistently gaining market share. 
• Revenue growth reflects a company's ability to command market share and provide capital to shareholders.

• the cost of goods sold
• the cost of depreciation
• the cost of amortization.
• Cost of sales reflects a company's ability to manage expenses so that revenue growth outpaces the cost growth over time.
• If Revenue growth is growing at 10% a year and Costs are growing at 11% a year, there’s a net loss of money over time.

• Gross Income is basically the profit available after subtracting the Cost of Sales. Gross Income will service other expenses, including raw materials, labor, manufacturing, payroll, administration, tax, interest payments, and R&D costs.

• Gross income growth reflects a company's ability to retain revenue and further fund its operating, financing, and investment activities.

• Gross Margins are measured in percentage terms to show the percent of revenue retained after-sales costs.
• Gross Margin growth reflects a company's ability to execute a profitable cost structure and grow earnings for investors.

• This includes raw materials, manufacturing, labor, payroll, and administration expenses.
• SG&A expenses will grow along with Revenues but should never exceed the growth rate of Revenues or Gross Margins.

• R&D expenses include building laboratories & hiring engineers to innovate. 
• Spending does not always equate to more profit therefore R&D must be observed in comparison to the industry average.
• R&D expenses are allowed to grow faster than other expenses because they often yield the requirements to produce superior products or services that challenge or disrupt competitors.

• Net income is basically the total profit left after paying all expenses

• Net income growth reflects a company's ability to retain revenue for shareholders and business activities.

• Net Profit Margins represent the percent of total revenue retained after all incurred costs. For example, 50% profit margins mean for every dollar spent, 50 cents became profits.
• Net Profit Margin growth reflects a company's ability to retain earnings and grow that retention over time.

• EPS is an acronym for earnings per share. EPS represents the amount of Net Income per share.
• EPS growth reflects a company's ability to return a profit to shareholders.

• EBIT is an acronym for earnings before interest and taxes.
• EBIT is an alternative measurement of profitability when comparing competing companies with different tax and/or debt structures that mislead corporate performance.
• EBIT is typically used when R&D expenses are higher than hard asset expenses; for example, Biotech stocks spend more on research and development than manufacturing stocks, so analysts will use EBIT to measure growth instead of Net Income or EPS.

• EBITDA is an acronym for earnings before interest, taxes, depreciation, and amortization. 
• EBITDA growth reflects a company's ability to generate profit through its operations while excluding Tax, Interest, Depreciation & Amortization expenses. 
• Although EBITDA can be misleading, it is a more precise measurement of corporate performance because it can show earnings before the influence of accounting and financial deductions. 
• EBITDA can be used to compare companies against each other and industry averages by eliminating extraneous factors.
• EBITDA can inflate a company's earnings with lots of debt and hard assets since the expenses associated with Interest from debt & Depreciation of hard assets are not included within the calculation.

2 | Balance Sheet 

The balance sheet provides a snapshot of a company's financial health:  liabilities, assets, debt & cash.

• Cash & cash equivalence growth reflects a company's ability to pay its short-term debts, cover operating expenses, finance an acquisition, or purchase inventory and therefore is a product of financial health.

• Equity represents the value that shareholders own if all the assets were liquidated and all the company debts were paid off.
• Equity Growth reflects a company's ability to increase assets over liabilities for overall health and future growth. 

3 | Cash Flow Statement: 

The cash flow statement provides a detailed report on the inflows and outflows of cash spent, invested, and retained.

• CFI typically shows negative cash flows because the short-term,  positive or negative depending on long-term investment such as R&D or asset debt.
• Capital Expenditure
• Lending Money
• Sale of Investment security

• CFF provides investors with insight into how well a company's capital structure is managed.
• Stock buybacks
• Dividends paid
• Short-term borrowing

• Payments on long-term debt

• FCF growth represents a company's ability to generate a surplus of value for investors, re-investment, and emergencies.  

Snapshot indicators 💨 

The Current ratio + LT Debt/Equity ratios are quick ways to gauge a company's financial stability regarding how many assets, liabilities & debts they hold. Learning how to read these ratios can save you time in determining the current risk of a company.Current Ratio​Current Ratio = Assets divided by Liabilities. ​
The Current Ratio is an apples-to-apples comparison that reflects financial stability or the ability to pay off short-term debt and or other liabilities compared to its competitors.

• a good ratio should be above 1.5.

• a ratio of 1 = 1 asset for every 1 liability 
• a ratio of 2 = 2 assets for every 1 liability
• a ratio of 5 = 5 assets for every 1 liability 

• A good ratio is around 0.5 or $0.50 of debt for every $1.00 of Equity.
• a ratio of 1 = $1.00 of debt for every $1.00 of equity

• a ratio of 2 = $2.00 of debt for every $1.00 of equity​

• a ratio of 0.5 = $0.50 of debt for every $1.00 of equity

• Higher P/E's can be considered overvalued or higher expected earnings
• Lower P/E's are considered undervalued

A companies P/E should be measured against its industry because industry standards differ. For example, high growth technology companies will have higher P/E’s than value companies.

• If a stock has a P/E of 20 and the industry average is 16, the stock can be considered overvalued relative to it’s industry. 
• If a stock has a P/E of 15 and the $SPY's price-to-earnings is 18, than the stock can be considered undervalued.
• If a stocks P/E is below the industry average or the stock market as a whole ($SPY) it’s considered undervalued.
• The stock markets P/E, represents $SPY (S&P 500) P/E represents the P/E of stock market as a whole