over 2 years ago

    Reading Financial Statements: Rev, EPS, Debt cover image

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    Reading Financial Statements: Rev, EPS, Debt


    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.

    Total RevenueTotal revenue tells us how much demand is being extracted from the market in terms of $USD. 
    • 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.
    Cost of SalesCost of sales is the total cost of supplying the product to meet demand. The Income statement reads "COGS + DA," an acronym for Cost Of Goods Sold + Depreciation & Amortization.
    • 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 IncomeGross Income = Revenue minus Cost of Sales.
    • 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 MarginsGross Margins = Gross income divided by Revenue. 
    • 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.
    SG&A expensesSG&A is an acronym for Selling, General and Administrative expenses, the basic cost of operations. 
    • 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 expensesR&D is an acronym for Research & Development expenses. 
    • 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 IncomeNet Income = Gross Income minus Total Cost (SG&A, R&D, Interest, Tax, Amortization, Depreciation). 
    • 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 MarginsNet Profit Margins = Net Income divided by Total Revenue. 
    • 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.
    EPSEPS = Net Income divided by total shares outstanding.
    • 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 & EBITDA 👇  are alternative ways to measure earnings)EBITEBIT = Net Income + Taxes + Interests or EBIT = Revenue - COGS - Operating Expenses.
    • 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.
    EBITDAEBITDA = Net Income + Interest + Taxes + Depreciation + Amortization.
    • 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 EquivalenceCash and cash equivalence are the most liquid assets, such as U.S bonds and other low-risk securities or money market instruments.
    • 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.
    Total Equity Total Equity = Total Assets minus Total Liabilities. 
    • 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.

    Cash from Operating Activities (CFO)Cash flow from operating activities is the sum of cash from investing activities and financing activities or the financial success of the core business activities. 
    Cash from Investing Activities (CFI)Cash flow from investing activities is the cash spent or generated through non-current assets intended to produce a profit in the future. 
    • 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

    Cash from Financing Activities (CFF)Cash flow from financing activities involves debt, equity, and dividends. 
    • 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

    Net Free Cashflow (FCF)Free cash flow represents a company's available cash to repay creditors, dividends, and interest to investors. 
    • 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 RatioCurrent 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 
    LT Debt/Equity RatioLT Debt/Equity Ratio = Total Longterm Debt divided by Total EquityThe LT Debt/Equity Ratio reflects the amount of financial leverage a company is using.</span>
    • 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

    P/E ratioPrice-to-earnings ratio = Price divided by EPS (earnings per/share)
    The P/E ratio is used by investors and analysts to determine whether a stocks price is overvalued or undervalued relative to it’s industry or relative to the S&P 500.  
    • 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