Financial Statements and the Investors

Interpretation and Analysis of Financial Statements for the Investors

The investor has to identify changes and trends in the financial statements to help explain some fundamental questiona and raise supplementary questions. For example:

Turnover: Is it Increasing?

If Yes:

• Is there a corresponding increase in Profits?
• Is there an additional investment in Fixed Assets?
• How is the additional investment Financed?

Investors derive their information from published sources such as annual reports, daily newspaper and magazines. Information contained in the annual reports is outdated, and is useful only for forecasting for the future plans and development. Information in newspapers and magazines may be more current and relevant for evaluating investments, but nonetheless still historical information.

Investors vary in their preferences. Some prefer high dividend pay-out rates and otheres prefer high capital gains: yet others may invest to gain control. Investors have to first establish their preferences.

A fundamental technique used to determine the share price is to study the dividend pay-out trend of the company. Investors who prefer a high dividend pay-out rather than capital appreciation should analyse the dividend policy of the company to decide whether to invest in, hold on to or dispose of, shares. Such investors should use dividend cover and dividend yield ratios to analyse the business. Companies with high ratios are preferred to those with low ratios.

Those who prefer capital appreciation to high dividends should study the PE ratio. The PE ratio relates the current price to the latest earnings per share. The PE ratio published daily in the newspapers compares the current market price of the share to the previous year's earnings per share.

The PE ratio represents the market's perception of a company's future performance in relation to its growth, gearing, risks and dividend policy.

• The value of PE ratio depends on the stock market environment and the industry a company is in.
• The average PE ratio varies from industry to industry. A careful study of the industry average gives an indication of the performance of the company in question.
• Shares with a PE ratio higher than industry averages are generally attractive to investors.

A high PE ratio of a particular share could imply that the company concerned has a high growth potential and is a leader in the industry. Alternatively the shares may just be overvalued. By contrast, a low PE ratio may indicate poor performance or undervalued shares.

Reference: How to Read Financial Statements by Jane Lazar