How to Analyze Financial Statements to Invest in Stocks
Financial statements are required for any company that wants to issue stocks to the public. The statements are used to provide full disclosure of all business and financial decisions that may be relevant to someone who wants to purchase stock in a company. While the statements are straightforward, they can be intimidating if you are unfamiliar with accounting and financial analysis. The following will help you to understand the three most common financial statements for investors looking to invest in a particular stock.
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Instructions
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Analyze the balance sheet. The balance sheet provides the investor with a snapshot (on one day of the year) of the assets, liabilities and stockholders equity of the company. The most important thing to look at on the balance sheet is how much debt a company has compared to the assets it owns. It's also important to understand the nature of the assets.
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Look up the line item "stock holder's equity" on the balance sheet. Often investors like to value a company based on intrinsic or book value. Stockholder's equity is the line item analysts use to determine a company's book value; this is, the value of a company's net assets. When compared to market value, book value will tell you whether or not a company (stock) is overvalued or undervalued.
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Analyze the income statement. Unlike the balance sheet, the income statement looks at the entire fiscal year for a company; that is, it is not a snapshot. The purpose of the income statement is to let the investor know about the revenues, expenses, and net income of a company.
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Look at the gross profit margin "(revenues minus costs of goods sold)" in order to compare business models. Look at the earnings per share. Compare earnings per share with the current market price of the stock in order to gauge whether the stock is undervalued or overvalued.
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Analyze the cash flow statement. The cash flow statement is composed of three sections: operating, investments and financing. This helps to understand where a company's cash is coming from. A company may turn a profit, but if the cash isn't coming from operations---that is, if cash if primarily flowing from financing and investing activities---the stock price might suffer in the future.
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