Tracy Byrnes
Who would've ever thought that Graham and Dodd, the progenitors of fundamental stock analysis, would be in vogue again.
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Read the MD&A
First, understand what business or businesses the company is in, says Robert Herz, chairman of the SEC regulations committee and a PricewaterhouseCoopers partner. Understand its product or services. You may be surprised to find that your company toils in nonrelated sectors. For instance, did you know that not only does GE (GE Quote - Cramer on GE - Stock Picks) bring good things to life in the kitchen, but it also produces nuclear power support services and military aircraft jet engines? If you own or are considering buying the stock you should know this because you're getting exposure to many different sectors. That's why reading "Management's Discussion & Analysis" should be your first step. It's the big narrative that comes right before the numbers section of the financial statements in the 10K or annual report. It should give you a good overview of what the company does and what's going on in the industry. It also is a good introduction to the company's operating results and current outlook.What's the Company's Growth Rate?
Then flip to the income statement and look at the total revenue number. (Note: revenue and sales are used interchangeably.) Instead of combing through the numbers in the report, you can use a good financial analysis site like Market Guide (my favorite). All the numbers you need to do a quick fundamental analysis are there. You want to see a positive total revenue number that's been increasing over time. That means sales are going up. How much is revenue increasing or decreasing? Figure out its growth rate. Calculate the percent difference between current year and prior years. Do it for the previous periods as well, so you can be sure that growth is increasing with time. Market Guide calculates this percentage for you. You can also see the company's growth rate over the past five years. Be sure to compare these numbers with those of industry peers.Can It Pay the Day-to-Day Bills?
The next number to analyze on the income statement is operating income. This number tells you if the company is making enough to run its day-to-day business. It's what's left after all its operating bills -- like marketing, payroll and utilities -- are paid. So ideally, you're looking for a positive number here. And again, you'd like to see it increasing over time. Why aren't we looking at net income? Because net income has other stuff in it -- like interest and taxes -- that have nothing to do with whether the company can run its day-to-day business. In addition, investment income is lumped into net income. That's the extra money the company makes from its investments in outside companies. But that's not money it made selling its product or services. So unless you can tear it apart, stick with operating income.It's Cliche, but Cash Will Always Be King
Do you balance your checkbook? You should (or you should have a software program do it for you). Well, you're not the only one with this tedious task. Companies have to do it, too. The cash flow statement is their checkbook, so flip or click to it now. It measures cash inflows and outflows over a given period and is one of the most important indicators of a company's financial health. It tells you where the company is getting its money from and where it's spending it. Look at "total cash from operating activities." Cash flow from operations tells you about the cash flow surrounding the sale of a product or service. If it's negative, that means the company doesn't have enough cash coming in to run its day-to-day business. That's a problem. Is your company a newbie? Then you might want to check out "net cash from financing." This is where all the venture capital money is reported. If that number is positive, it means there are investors out there that have helped to finance the company. You can take some comfort in that if your young company has negative cash from operations. Finally, look at the total net change in cash. Overall, you'd like to see a positive number. "In tough times, cash is what you need to survive," says Ashok Ahuja of Icor, a Westport, Conn., firm that operates a technology hedge fund.You Have to Start Somewhere
There are many different numbers to investigate when analyzing financial statements, but looking at these few should give you a basic understanding of what your company does and where it stands financially. So dust off your security analysis books -- and this time, don't put them away.Send your questions and comments to investorforum@thestreet.com, and please include your first and last names. Investor Forum appears Tuesdays, Thursdays and Saturdays.
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