The Edge

A 10 Minute Checkup To Determine A Company’s Financial Health

Quarterly earnings announcements are probably the most important news events for publicly traded companies and their shareholder. Anybody that’s been around the investment game long enough has owned stocks that popped or got dropped after a company released their financial report card.

Sometimes, Wall Street’s reaction is like Yosemite Sam shooting his pistols in opposite directions, earnings are better than expected and the stock price gets whacked. For the savvy investor, this double-cross can be an excellent opportunity.

Facebook, Inc. (FB) comes to mind. Traders dumped the stock after one of their first quarters post-IPO based on concerns management wasn’t monetizing their assets. After a quick review of FB’s financial statements, it was clear that the kneejerk reaction to sell created an opportunity to buy.

Here is a quick and easy way to evaluate a company’s financial statement without being an accountant.

Step 1: Got to https://finance.yahoo.com/ and enter the symbol of choice. Then select profile from the stock specific menu.

On the profile page, you will see a link to the company’s website, click on it.

Step 2: Sometimes the link with take you directly to the investors’ relations page and sometimes you’ll have to find the link. If it’s not readily viewable on the home page, most of the time it’s listed in the footer at the bottom of the page.

Step 3: Once you are on the investors’ relations page, look for the menu item/link for SEC Filings. In most cases, there is an option for annual and quarterly reports. 10-Qs are the quarterly earnings reports and 10-Ks are the annual reports. Check both annual and quarterly to find the latest date to make sure you are using the most recent numbers.

Step 4: Select the format of your choice, we prefer excel.

Step 5: Now we get into the numbers.

 

Income Statement:

The first thing you want to do is calculate year over year and quarter over quarter sales and earnings growth. If they are in line, it’s usually a good sign. For example, if sales rose 10% and earnings per share are up 12%, that’s normal. However, if sales are up 10% and earnings are up 100%, that could be a red flag. At the very minimum, you want to know why the top and bottom line are so out of whack.

Next, calculate administrative, selling and general expenses, cost of goods sold, sales and marketing and research and development as a percent of sales for the most recent period, the same period a year ago and last quarter. Hopefully, you will find that costs dropped or at least remained constant relative to sales in the most recent quarter.

As a rule of thumb, lower costs can lead to higher profits especially in cost of goods sold and general expenses. An increase in sales and marketing or research and development might hit a stock in the short-term but tend to have longer-term benefits, which was the case with Facebook.

Balance Sheet:

Once again, we are going to use revenue for the most current quarter, the same quarter a year ago and last quarter as our measuring stick.

This time take accounts payable, accounts receivable and inventory and calculate their percentages relative to revenue for the three timeframes outlined above. Once again, the hope is to see the most recent quarter inline or lower than the previous timeframes of interest.

If you see accounts payable are growing as a percentage of sales, it can mean the company is slow to pay their bills. It’s not always a bad sign, but the company could be hanging onto cash to inflate earnings. Keep an eye on it.

If you see accounts receivables rising, it might mean their customers are slow to pay their bills and a potential sign that business conditions are deteriorating. If so, pay attention to sector related news for any information that confirms or alleviates concerns.

Inventory, we learned about this one the hard way. You might recall those shoes kids wore that converted into roller skates with wheels embedded in the soles. The company was called Wheelies. Our research indicated Wheelies was going to report a blowout quarter and they did on the sales side but missed earnings forecasts.

We expected the stellar numbers to pump up the stock dramatically. Instead, Wheelies’ stock price got shaved like a hippie’s head in the Army during the 60s. The reason, management overestimated demand, built too much inventory and took a massive write off.

Rising inventory as a percentage of sales can also point to a slowing business climate and lower profit margins.

Of course, the opposite for every worry we laid out above is true if the most recent accounts payable/receivables and inventory fall as a percentage of sales. A drop in the percentages can mean improving business conditions and wider profit margins; all of which are generally good for stock prices.

Following these quick and easy steps will allow you the have a better sense of a company’s financial health in a few minutes and you don’t need to be an accountant.