Good investors knows that before buying a company’s stocks, they should read the company’s financial statements to find out more about the current state of its funds, and in order to make a judgement call about how they feel the company will perform in the future.
However, for people who aren't trained in finance, financial statements often seem complex and difficult to understand. Without realising it, they might also miss out on red flags that a company isn't a good investment.
So what information should a potential investor look out for in a financial statement? Here are 6 key aspects to consider:
1: Find out who’s on the board of directors and management team
As an investor, you are at the mercy of the management team to make the correct
decisions with your money, and you’re counting on the board of directors to keep a watchful eye on them. If you can’t trust the people running the company, you shouldn’t trust them with your investment.
2: Look at the company’s track record of paying dividends
Dividend payments often account for roughly 4% of the returns generated by stocks over time. Steady dividends can make sure you’re earning something on your money even if the stock is flat.
3. Compare the company’s promises with its performance
It is up to you to verify claims made by a CEO. If the CEO says a new product is selling like crazy, take time to look at the company’s revenue growth and also the accounts receivable turnover, to ensure customers are actually buying and paying for the goods.
4. Watch out for indications that a company is overly showy
Some athletes get themselves into trouble when they decide to showboat. Companies, too, can sometimes get full of themselves. Some companies build opulent headquarters; send employees on overly lavish business trips; or spend millions on vanity promotions (e.g. sports sponsorships) – which have little or no benefit to the bottom line.
5. Assess if the company is struggling with change
Companies often struggle with the transition from a fast-growth company to a slower growth one, and often they need to change their entire strategies. Also, be mindful of game-changing technologies or new ways of doing things that can render a company’s business model obsolete.
6. Consider what’s a fair price to pay for a stock
Remember, stock prices are set by the constant tug of war between buyers and sellers trading shares back and forth. Studies have shown that growth stocks, or shares of companies with the highest valuations measured by investment ratios, are often the biggest disappointment for investors.
In addition, calculations of so-called leading stocks are often driven up so high that their future returns are often disappointing, so take time to read statements released by a rival company you might consider to be weaker, in order to get a better picture.
Liked this article? Sarjit will be presenting the course: Financial Analysis Techniques: A Masterclass on 25 Mar, teaching investors how to assess financial statements and suss out potential issues in a company.
More information about the course is available here.
About the author
Sarjit Singh Sandhu, BBM, PBM, is the former CFO of AIA Singapore and AVIVA Asia. He worked for PwC for 16 years, leading the audit and advisory engagements for MNCs, listed companies and financial institutions in Singapore, Australia and the USA. He has taught at SGX, MAS and ISCA.