Financial statements exist to allow outside investors to know where a company stands financially (Balance Sheet), what the company is producing in the way of return (Income Statement), and how the cash is being managed (Statement of Cash Flows).
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If you were to look at a lot of companies and their stock prices, you could often conclude that the balance sheet does not seem important at all. I’ve mentioned before that there are numerous companies that sport a healthy stock price while also carrying a negative tangible book value per share. In such cases, future expected earnings must uphold the stock prices because no case can be made from the balance sheets that solid underlying equity support exists.
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Another college semester is winding down. This semester, I’ve taught a course on how to analyze the financial statements from the lender and investor perspectives relative to financial decisions made by these parties. The students have been wonderful and we have had a very spirited discussion across the term.
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Most stock market participants don’t give much attention to the equity of a company, found on its balance sheet, when it comes to setting a value for the company through the present stock price. This is amazing to me since a share of stock represents a share of company equity.
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My book, “Choose Stocks Wisely,” is all about the importance of the balance sheet equity (described as Stockholders’ Equity on the balance sheet) toward properly evaluating the quality and worth of a share of common stock. When you buy a share of common stock in a company, you are buying a share of the equity. So, analyzing the balance sheet equity of a company before investing money into that company is not only logical but also essential.
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Recently, a reader of my book, “Choose Stocks Wisely,” asked about the difference between common stock and preferred stock since he had come across these two types of stock in books he had read. This is an important issue since some corporate balance sheets have both types of stock listed under Stockholders’ Equity.
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This is a question I’m receiving a lot lately and, frankly, a question worth pondering. I’ve never read about anyone who consistently (time and time again) has correctly predicted the end of bull or bear markets, or even consistently predicted the timing of temporary market corrections. Far be it from me to attempt to do so. Many people got out of the stock market near the lows of late 2008 and early 2009 and have missed one of the largest market increases since then in the history of the stock market. Emotions tend to make investors “react” and thereby “act” at just the wrong times.
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I’ve received several e-mails from readers of my book, Choose Stocks Wisely, who have observed that financial companies don’t have the subtotals for “current assets” and “current liabilities” on their balance sheets. These amounts are required as inputs by my Adjusted Floor Price Scorecard, specifically to complete Part A on testing for adequate liquidity.
Further, two of my finviz.com screening filters are the quick ratio and the current ratio. Both of these ratios require that the current asset and current liability amounts be available. Thus, banks and other financial companies will not satisfy my screening filters due to “lack of available data.” Keep in mind, to run a finviz screen which can potentially yield financial company stocks among non-financial company stocks, any filter that depends on a current/non-current balance sheet account breakout must be excluded as a filter.
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I talked this week about financial leverage during one of the college courses I’m teaching this semester. Financial leverage describes the use of debt financing as a means of levering earnings higher. Using debt financing is like using a crowbar on earnings. Indeed, when a company is experiencing profitability, it can enhance profits through the benefits of using debt to finance the assets used in operations.
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I’ve been blessed to experience wonderful friendships across my life. What a privilege to teach accounting to people in college over the years! I feel I’ve already made new friends via the website-enabled interaction that surrounds my book, “Choose Stocks Wisely.” Tonight, I will briefly share a very recent interesting question I received.
A reader of my book wrote the following:
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