I would love to learn to move beyond my current quite surface level analysis, which consists of reading stock reports and watching videos of CEOs being interviewed. – Ben
Paul Scott, an experienced UK stocks analyst had this to say.
It’s an interesting point you make on more detail as some would say less is more to avoid conformation bias, others like to pick at the bones. It depends on many factors including the time you have, your investment style, your thirst for knowledge on a particular company, your ability to not become sucked into a company the more you read, research and watch.
For me I like the numbers to do the talking, so carry out the above forensics, check historical RNS’s on a company that pass the screen test, check broker notes through research tree, execute buys from my watch list avoiding FOMO using level 2, basic charting, and where we are in the economic cycle. Then carry out tight portfolio management cutting losing shares early, and running winning shares. Sounds so easy when you write it down….not so easy in practice.
Remember stock picking is only half of the equation, as plenty of well researched shares simply go down. I find that when to buy, when not to buy, and when to sell are really the key drivers for a successful investor (making money!).
Balance Sheet Analysis
by Jack Brumby
There are three main sections to a balance sheet: assets, liabilities, and equity. Assets are what the company owns and include cash and property. Liabilities. are what the company owes and include debt. Equity is what’s left over when you subtract L from A.
Assets = liabilities + equity.
You want high quality assets comfortably above liabilities. If assets are largely made up of intangibles or goodwill that can itself be a warning sign.
You can get quite far quite quickly. I’m a big believer in the 80/20 rule and there are some easy checks that can quickly flag up any warning signs:
- From the StockReport, first check if the company is profit or loss-making in the first box of the Financial Summary. Also is revenue increasing or declining? Trends can be important. Consistently loss-making or those with declining revenue need strong balance sheets or cheaper valuations in order to make the risk/reward attractive.
- The Cashflow box is similarly useful – if the company is spending more than it is earning, and Free Cashflow ps is consistently red, that again is a warning sign. The company should have cash on its balance sheet in this instance, as it likely can’t fund itself from its own operations.
- Then at the bottom of the Financial Summary, there is the Balance Sheet box. This shows the net cash/debt balance. Watch out for: cash going down, net debt increasing, and/or average shares going up.
- The Professor Scores to the right are very useful. It’s worth clicking on the F-Score and Z-Score to show which checks the company fails – this can point you towards warning signs for more detailed investigation on a stock’s Balance Sheet page.
This is just a quick start – entire books are written on Balance Sheet analysis – but you’d be amazed at how far these few steps can get you. Also a stock with a high Quality Rank is likely to have a strong Balance Sheet.
How Fund Managers Do the Research
Stocko is also good at summarising the historic financials at a high level, but that is just a starting point.
If you were to sit down with an analyst at a fund management firm or a brokerage firm/investment bank you would observe a much more detailed process. At a minimum they would restate the accounts, adjusting for leases, assets held at cost, exceptionals that aren’t exceptional, the “polishing” of inventory/cash levels for period end, depreciation policy, share based compensation and then rebuild the P&L and balance sheet so they can observe relative valuation on a “clean” basis – apples vs apples. Look at the latest Fundsmith letter for an example of how this changed their view on Intuit vs Microsoft.
The accounts however are the easy bit. Much more difficult is trying to get a handle on the competitive position, the sustainability of margins, the likely future growth in revenues etc. Even the best analysts can’t forecast out more than a year or two before it all becomes a guesstimate – which is a big problem because a large part of the value in any share resides in the terminal growth assumption (look into DCF valuation for more on this)
An analyst will easily spend a week on a single stock, if not longer. Some firms will even do their own primary research – measuring footfall etc. Meeting the company in person is a two-edged sword, in that you gain insight, but their enthusiasm/bias rubs off on you…..
There are more companies than any individual can ever cover in sufficient depth – investment outfits that are just one fund manager will be highly dependent on sell-side research, which their rivals also see.
There are plenty of books on this, but stick to recent publications simply because accounting standards are constantly changing, and can differ by region.