1/19/2024

Financial statements: how to analyze

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Investors should carefully review a company’s financial statements before deciding whether to invest in it. Of course, net income is an important indicator of a company’s success, but it is not the only factor to consider when buying a stock.

Net profit is a good indicator of how effectively a company manages its resources. However, net income may not reflect the overall picture due to various factors such as company structure, industry competition and economic conditions.

Below we will talk about other criteria that you should pay attention to when choosing a company.

 

Operating profit

Operating income is a company’s funds after subtracting all operating expenses, including cost of sales, general and administrative expenses, and depreciation. It shows how effectively a business uses its resources to create profits.

Also related to this is the operating profit margin, which is the percentage of operating profit generated from sales. It is calculated as operating profit divided by revenue. A high operating profit margin indicates that the company is effectively managing costs and generating revenue.

 

Assessing share price and shareholder profitability

Investors use a company’s financial statements to evaluate its value and profitability to shareholders. Earnings per share (EPS) is a measure of the profit a company makes per share. It is calculated as net income divided by the number of shares issued. The price-earnings ratio (P/E) is the ratio of a stock’s price to its earnings per share. It shows how much investors are willing to pay for each unit of a company’s profit.

Finally, the price-to-book ratio (P/B) is calculated, which is the ratio of the share price to the company’s book value per share. It shows how much investors are willing to pay for each unit of a company’s assets.

 

Dividend payout ratio

The dividend payout ratio, a key metric for assessing a company’s financial health and shareholder commitment, indicates the percentage of earnings distributed to shareholders as dividends. A higher ratio suggests greater reliability of earnings to support dividend payments and overall stability of the company. Meanwhile, retained earnings, representing the portion of earnings not paid out as dividends, reflect the company’s reinvestment in future growth and expansion.

 

Assets and liabilities

Examining the assets and liabilities outlined in a company’s balance sheet offers investors a dependable insight into the company’s overall financial well-being and its debt status. Utilizing debt ratios, such as the current ratio derived from the financial statements, enables analysts to assess the company’s capacity to manage its existing debt. Additionally, substantial capital expenditures serve as indicators of a company’s present financial condition and can provide insights into its potential for growth.

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