The Smart Way to Analyze a Company’s Financial Results

If you are an investor, you will more than likely agree that you need to know a good deal about a company before buying stock in it. You will also likely agree that one of the most important things to know about a company is how well it has managed its finances. After all, a company that doesn’t manage its finances well won’t be as likely to be profitable, which means that it will more than likely not be a very good investment.

So what should you know about a company’s finances? There are so many numbers on the financial statements. Do you really need to read every line on every financial statement?

A more sensible approach would be to pick a small number of smart and targeted metrics that you can use to predict a company’s future trajectory. For example, it can be helpful to look at a company’s current debt level, but this in itself probably will not tell you a whole lot about the company’s financial health.

On the other hand, if you are able to, for example, see that a company has been steadily decreasing its debt level over the past several years while at the same time earning a greater rate of return on its invested capital, this is probably a sign of good things (and profits) to come.

With this in mind, how can you decide which metrics to use, and how many? You will want to start by picking a few targeted metrics like ROIC (Return on Invested Capital), ROE (Return on Equity) Growth, debt-to-asset ratio deceleration, dividend payout ratio increase, or EPS (Earnings Per Share) Growth. Picking a small number of targeted and predictive measures can help you to paint a clearer picture of the company’s finances and its trajectory.

Let’s look at a quick example. Using the metrics outlined above, let’s assume you are researching company X. You notice that company X has had an increasing EPS over the past several years. However, you also notice that its dividend payout ratio has also decreased and its debt-to-asset ratio has also steadily increased.

If you had only observed the increasing EPS, the stock would look good. But looking at the increased EPS in light of the lower dividend payout and increasing debt yields a much less optimistic picture of the company’s financial health and future direction.

In conclusion, make sure to study the financial statements, but don’t get too bogged down in the numbers. Analyzing some targeted metrics and understanding how they make sense in light of a company’s competitive position can go a long way in helping you to consistently make better investing decisions.

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