Reading financial statements for value investing
Warren Buffett Accounting Book: Reading Financial Statements for Value Investing by Stig BrodersenExcellent book for rookie investors. Some notes:
A. Must-know Concepts
1. Interest rate
-> [when contraction] Low: easier to borrow money -> demand up -> spending up -> supply up -> GDP up
-> unemployment down -> wealth up -> inflation up -> price up -> currency down
-> bubbles on the way
-> stocks are cheap -> buy stocks
-> [when expansion] High: discourage in borrowing money -> demand down -> spending down -> supply down -> GDP down
-> unemployment up -> wealth down -> inflation down -> price down -> currency up
-> Buy bonds
-> more money in the circle -> consume more -> demand up -> spending up -> ...
-> more (hidden) tax to government
-> pay debt (use real inflated currency to pay off nominal debt)
-> stock return down
-> bond interest down
-> good when interest rate is high and|or inflation is low
B. Core principles of value investing
1. Vigilant leadership
- Low debt: -> low debt-2-equity (<= 1) -> good solvency -> OK in long run
- Big working capital -> high current ratio (>= 1.5)-> good liquidity -> OK in daily business routine
- Strong and consistent return -> high and consistent ROE (>= 8% in 5-10 years, depends on specific industry) -> good profitability
- Appropriate management incentives -> management board is good and dedicated to business
2. Long-term prospects
- Persistent products: -> do technology advance affect somehow on products?
- Tax efficiency: -> Long-term investment cost less tax
3. Stock stability
-> Business: understandable and stable
- Stable book value: -> high and consistent owner earning -> EPS growth, FCF growth
- Economic moats: -> durable competitive advantages -> overcome competition in long run
4. Buy at attractive prices
- wide margin of safety to intrinsic value -> buffer for any error in value estimation and risk assessment
- Low price multiples: low P/E (<= 15), low P/B (<= 1.5) (depends on specific industry)-> likely undervalued stocks
- Set a safe discount rate: -> a kind of risk coefficient -> the riskier the investment, the higher the discount rate
-> also equivalent to the ROI (required rate of return)
-> use a benchmark like bond interest
- Estimate intrinsic value: -> DCF model or Buffet adjusted DCF model
- Sell if stocks break any core principle
Ben Graham on Interpreting Financial Statements
Why Zacks? Learn to Be a Better Investor. Forgot Password. Financial statement analysis can help stock investors digest hard-to-read financial statements. The company's income statement, balance sheet and statement of cash flows are especially useful to understanding how a company functions, its stability and how much its stock is worth.
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Situation 1: We find an undervalued company based on balance sheet analysis
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value. Value investors actively ferret out stocks they think the stock market is underestimating. They believe the market overreacts to good and bad news, resulting in stock price movements that do not correspond to a company's long-term fundamentals. The overreaction offers an opportunity to profit by buying stocks at discounted prices—on sale. Warren Buffett is probably the best-known value investor today, but there are many others, including Benjamin Graham Buffet's professor and mentor , David Dodd, Charlie Munger , Christopher Browne another Graham student , and billionaire hedge-fund manager, Seth Klarman.
In this book, you will learn how to: Pick stocks like Warren Buffett Calculate the intrinsic value of stocks using two methods During the second half of the book, readers will learn in-depth methods for: Read an income statement Read a balance sheet Read a cash flow statement Calculate and interpret key ratios. Read more Read less. Customers who bought this item also bought. Page 1 of 1 Start over Page 1 of 1. AED
This ratio indicates the ability of a company to pay its expenses in the near future. A healthy working capital number shields the company from being unable to meet demands, fund emergency losses and helps with the prompt payment of bills. Graham further advises the individual to analyze the working capital over several years to watch its corresponding incline or descending levels. The current ratio can be calculated by dividing the current liabilities from the current assets. A quick asset ratio of is regarded as a reasonable number. It should be recognized how high the value of goodwill is presented, or not presented at all. Graham further explains that companies vary dramatically in how they present goodwill on their balance sheet.