Monday, 30 November 2009

Doing Your Homework: Analysing Financial Statements to pick Great Stocks

How do you pick great stocks?

If you don't have a crystal ball or inside information, then the best way you can tell a winning stock from a loser is by analysing a company's financial statements.

Before you dismiss this simple answer because you find financial statements confusing or boring, you should know that you don't have to become an accountant or financial analyst.  Just a nodding acquaintance with the fundamentals will allow you to make better decisions about
  • which stocks you should investigate and
  • which stocks you should own as part of your (e.g. dividend-focused or growth-focused) portfolio.

Financial statements are an important source of information regarding a company's profits or losses, assets and liabilities, and sources of funds used to operate its business.  You should concentrate on the basics: 
  • the balance sheet,
  • income statement, and
  • statement of retained earnings.

The balance sheet
This gives you an overall picture of a company's assets, liabilities, and equity at the end of an accounting period (i.e. quarterly or year-end).

The Income statement and the statement of retained earnings
These tell you how much revenue, expense, and profit the firm generated over a specific period of time (e.g. its fiscal year).

Together, these statements provide you with all the financial data you need to perform a ratio analysis to determine if you would want to buy a stock.

Since financial transactions occur continuously, this information becomes rapidly dated.  Be sure you are looking at the most recent statements and continue to review the updated statements of those stocks you decide to hold.

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