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  • 1. Personal Finance How To Analyze Investment Like the Pros
  • 2. TABLE OF CONTENTS By The Editors Of Personal Finance The Hard Facts 1 Collecting Data 2 The Ratios 8 Technical Indicators 20 Selected List Of Company And Industry Information 23 KCI Communications, Inc., 7600A Leesburg Pike, West Bldg., Suite 300, Falls Church VA 22043. Subscription and customer services: P.O. Box 4106, McLean, VA 22103, 800-832-2330. It is a violation of the United States copyright laws for any person or entity to reproduce, copy or use this document, in part or in whole, without the express permission of the publisher. All rights are expressly reserved. 2008 KCI Communications, Inc. Printed in the United States of America. PTA1207-TG. The information contained in this report has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed.
  • 3. The Hard Facts Without financial facts and figures, professional analysts couldnt make informed decisions. Financial analysis demonstrates how past conditions and events came to pass; more important numbers exhibit what could happen in the future. The real purpose of this analysis is to identify proba- ble outcomes if certain actions are undertaken. For exam- ple, if past sales growth averaged 10 percent annually during a 10-year period and if the management team remains intact, we might logically expect the trend to continue. What numbers do the pros use? Most analysts use the raw information presented by accountants concerning sales, margins, expenses, profits and taxes. Unfortunately, the numbers themselves tell only part of the story. The trick is to know what the numbers mean and to relate them to each other and to industry norms. Financial analysis is designed to determine a companys relative strengths and weaknesseswhether the firm is financially sound and profitable relative to other firms in its industry and whether its position is improving or deteriorat- ing over time. Analysts need this information to estimate the riskiness of the endeavor under consideration and to determine if the firm is worthy of an investment. Of course, the numbers arent the whole story. There are psychological factors that affect the stock market. Some ana- lysts say the stock market is 15 percent numbers and 85 percent psychology, following the postulate that all invest- ment issues are human related. Thats why savvy analysts use intuition and psychology to supplement the numbers. But without a solid grasp of how the pros use numbers, youll never be in the major leagues of investing. The tech- niques contained herein and in Personal Finance will help you become a confident investor. 1
  • 4. Collecting Data The first concern of the analyst is finding reliable infor- mation. Where do you look? The most commonly employed information, and the most dependable, is historical. Of the various reports corporations issue, the annual report is by far the most important. The Annual Report Financial Statements Principally, the annual report provides two types of infor- mation: a description of the firms operating results during the past year and a discussion of new developments that will affect future operations. The report includes four basic financial statements: the income statement, the balance sheet, the funds flow statement and the statement of changes in owners equity. Taken together, these state- ments depict the firms operations and financial position. In order to evaluate the merits of an investment, investors look for information that tracks the business and try to under- stand the flow of funds into and out of the firm. This process involves reviewing a great deal of formal or informal data rele- vant to the specific purpose of the analysis. Almost all of the data needed is found in the following financial statements. 1. Balance Sheet The balance sheet describes the categories and amounts of assets utilized by the business and the offsetting liabilities incurred by lenders and owners. Sometimes called the statement of Balance Sheet financial condition, or statement of Assets = Liabilities + Owner Equity financial position, it must always Assets Liabilities balance. Why? Because the total Current assets $50 Current liabilities $26 assets invested in the business at Fixed assets 125 Long-term liabilities 97 any point in time, by definition, are Other assets 2 Owners equity 54 Total assets $177 Total liabilities $177 matched precisely by the liabilities and net worth and owners equity position. 2 How To Analyze Investments Like the Pros
  • 5. The balance sheet is sometimes reduced to a simple accounting equation: assets = liabilities + owner equity (see box on p. 2). Ultimately, all transactions appear within this basic equation. The balance sheet assigns values to equipment and other assets, describes amounts owed on both short- and long-term horizons, lists funds available for continued operation of the business, and determines the value of the stockholders equity. Keep in mind that balance sheets can become obsolete very quickly. Like your monthly bank statement, they reflect conditions on the compilation date. The major categories of assets are: current assets (items that turn over in a short period of time, such as cash, mar- ketable securities, accounts receivable and inventories); fixed assets (buildings, land, mineral resources, heavy machinery, vehicles, etc., all of which are used over the long haul); and other assets (deposits and intangibles like copy- rights and patents). Major liabilities include: current liabilities (obligations to distributors, tax authorities, employees and lenders due within one year); long-term liabilities (an assortment of debt instru- ments like mortgages and bonds); and owners equity (funds contributed by various classes of owners of the business as well as accumulated earnings Income Statement retained in the business). Revenues - Expense = Profits 2. Income Statement Sales $4,000 Costs and expenses 2,400 The income statement describes the Writeoffs 100 dollar value of goods and services sold, Depreciation 100 gross profit, funds expended to make profits happen, including writeoffs and Earnings before interest and taxes $1,400 taxes, and how much net profit or loss Interest expense 25 resulted. The income statement is some- Earnings before taxes 1,375 times referred to as the operating state- Taxes 475 ment, earnings statement or profit-and- loss statement. Net Income $900 3
  • 6. Where the balance sheet reflects the financial condition on a specific date, income statements tell what happened over a period of time, usually one year. The net profit earned by a business enterprise is found by deducting expenses from revenues, or in equation form: revenues - expenses = profits (see box p. 3). 3. Funds Flow Statement The funds flow statement, or the statement of changes in financial position, provides the basis for an aggressive analy- sis that focuses on the changes in financial condition result- ing from management decisions made during a given time