Interpreting Financial Information Securities and Investments

COMPONENTS OF THE ANNUAL REPORT: Letter to shareholders Financial highlights Charts and graphs Financial statements Additional notes Company information While there are many sources of information that investors can use to assess the value of an investment, one of the most common and easy to locate documents is the Annual Report. This report is available for every publicly-traded corporation and provides a great deal of information that can be examined and interpreted by any investor. Locate an annual report online using any search engine; the easiest search engines being the ones with a separate Finance link. Then locate each of the above sections which are common to most Annual Reports. As you proceed through this presentation, refer back to these sections of the report. You can also search for different companies’ reports to demonstrate the similarities in the formats.

Financial Statement – The Balance Sheet Provides information about: Assets (Property)-current (cash) and long-term (land, buildings) Liabilities (Loans)-current (accounts payable), long-term (notes payable) Net worth or stockholder’s equity The purpose of the Balance Sheet is to provide information internally to employees and externally to investors regarding the assets (property), liabilities (debts), and net worth (stockholder’s equity) of a company.

Financial Statement – The Income Statement Provides information about: Revenue-income from sales Expenses-operating expenses such as salaries, rent, and utilities Net income/Net loss-revenue minus expenses The purpose of an Income Statement is to account for sales generated less associated costs, called expenses, of running the business and generating the sales. The amount left over, if positive, is Net Income. If the amount after costs is subtracted from sales or revenue is negative, that is a Net Loss. Search online for various companies’ Annual Reports to locate the Income Statement section and determine if there is a net loss or net income.

Financial Statement – The Cash Flow Statement Look for: A positive number in cash flow from operations Negative numbers in the investment section are not necessarily bad because it may mean the company has money to invest Negative numbers in the financing section may not be a red flag either because the company could be paying out dividends or purchasing stock back from investors Cash is an important asset for any business. The more cash that is available from operating the business, the more cash is available to continue to operate and possibly expand the business.

What to Look for In Financial Statements Has balance sheet improved over the years? Is there net income or net loss? Is cash flow negative or positive? Has cash flow from operations been increasing? Are there risk factors or any legal actions? Have gross margins been increasing? Calculate various ratios from data in annual reports Aside from specific numbers and ratios in financial statements, patterns from one year to the next are also important indicators of the direction a company’s financial condition is taking.

What is a Prospectus? Information provided by a corporation about an investment offering For mutual funds, look for: Management fees Performance Risks Price per share A prospectus is a document that is published to disclose information about investment offerings. For example, for a mutual fund, the prospectus will have the price per shares of the Fund, previous performance of the Fund, the major risks associated with the particular Fund, investment strategies, any and all fees, among other information. This information can be helpful in determining whether or not someone may be interested in investing in this security. Conduct online research for a variety of different funds, noting the fees involved and the performances for the previous one-, five-, or ten-year periods.

Fundamental Analysis Uses data from financial statements to value stocks and bonds Uses the credit rating of a bond issuer Looks at interest rates and economic factors Warren Buffett-firm believer in fundamental analysis Aside from financial statements and mutual fund prospectuses, there are other forms of analysis: fundamental and technical. Fundamental analysis emphasizes using data, mainly from financial statements, to determine how favorable an investment may be. Warren Buffett preferred this type of analysis and was extremely successful using it.

Technical Analysis Relies on historical performance of a stock in predicting future success Also relies on market trends Supply and demand-important factors Technical analysis, rather than relying on financial data, relies mostly on the historical performance of the investment itself. It also examines market trends as well as the supply and demand for the investment.

Financial Ratios – Liquidity Definition Significance Current Ratio Current Assets/Current Liabilities Determines whether current assets can be enough to pay off the short-term debts; higher is usually better. Quick Ratio Current Assets-Inventory/Current Liabilities Similar to current ratio; subtracts inventory from assets because they may not be as liquid. The higher it is, the better. Investors may find financial ratios useful in determining if a potential investment is a good idea or not. Liquidity ratios are important in that they can assess the proportion of debts a corporation has relative to its assets. In these ratios, generally the higher the ratio, the better.

Financial Ratios – Profitability Definition Significance ROA-Return on Assets Net Income/Average Total Assets Determines how well a company’s assets are being used to make a profit. The higher the %, the better. ROE-Return on Equity Net Income/Average Total Common Equity The higher the %, the more the stockholders’ investments are paying off. Investors like to know how profitable a company in which they may invest is. The ROA and ROE ratios can determine this. They both look at net income; the higher the percent, the better.

Financial Ratios – Debt Definition Significance Debt Ratio Total Liabilities/Total Assets The higher the %, the more risky position the company is in because its debt is higher. Debt-Equity Ratio Total Liabilities/Total Stockholder’s Equity The lower the %, the better. Shows the % of debt held by suppliers and other creditors as compared to how much shareholders have invested. The debt ratios can generally determine the proportion of debt to suppliers and other creditors compared to a company’s assets and also to the amount invested by shareholders. Generally, the lower the percentage, the less risky the investment in that company is.

Financial Ratios – Operating/Cash Flow Definition Significance Fixed Asset Turnover Rate Revenue/Property, Plant and Equipment The higher the rate, the better. Demonstrates that these higher-priced assets are generating sales. Must consider company type (e.g., an Internet company versus an industrial equipment company). Ratio Definition Significance Operating Cash Flow/Sales Ratio Operating Cash Flow/Revenue The higher the %, the better. Shows effectiveness of accounts receivables paying down balances. Investors may want to know how effective a company’s assets are at generating sales, or revenue, for a company. Usually, the higher this turnover rate, the better; however, investors should be cautioned that some companies can be very profitable and do not have the extent on these long-term assets that other companies have. For example, Internet search engine companies and service businesses may not have as much in the way of long–term fixed assets compared to a large manufacturing company; therefore, this ratio may be somewhat skewed.

Financial Ratios – Value of Investment Definition Significance Price/Earnings Share price of stock/Earnings per share A higher number usually indicates higher growth relative to the market. Dividend Yield Annual dividend per share/Share price of stock A higher % indicates a higher dividend payout based on the price per share. Utility companies typically may pay more dividends than growth companies. There are other indicators of potential investments that can be significant. Depending on your needs as an investor, you may be looking for growth companies with higher price-earnings ratios or more stable companies with p/e ratios of between 8-18. You may be looking for income stocks which provide for payment of dividends. These are typically utility companies as opposed to growth companies.

Financial Ratios – Value of Investment Definition Significance Price/Book Value Ratio Share price of stock/Stockholder’s Equity per share * (Stockholder’s equity per share=stockholder’s equity on the Balance Sheet/Number of shares outstanding) If stock price < book value, stock can be a good value, possibly. If the stock price > book value, some may think the stock price is too high. A financial ratio important to investors is the price-to-book value ratio. This provides a way to possibly assess whether a company’s stock could be over- or under-valued.

Formal Assessments Annual Report Analysis Assignment #1 - Select two companies and conduct Internet research to locate their annual reports. Create a table or diagram comparing at least 5 different ratios for the companies using the Balance Sheet, Income Statement, and/or Cash Flow Statements. Make a recommendation on whether or not investing in stock in these companies would be a profitable idea.

Formal Assessments Mutual Fund Venn Diagram Assignment #2 – Create a diagram comparing and contrasting 3 different mutual funds by searching online for ‘mutual fund prospectuses’. The outer circles will contain the name of the fund and the price per share of the fund. Include other pertinent information: a statement summarizing past performance of the fund, risks of the fund, management fees, and the investing strategy of the fund. These may be included in the outer circles as well, but any information that is common to all three funds should be placed in the overlapping parts of the circles in the Venn diagram.

Formal Assessments Company SWOT Analysis Assignment #3 – Following the example of the SWOT analysis done as a class, select a company (the teacher can randomly place company names under each chair in the room and the students can see which company name is under their chair) for which to conduct a SWOT as an alternative investment strategy. This analysis may be done on a computer using any of the available templates online or manually on posterboard or flipchart paper. Include an investment recommendation based on the SWOT analysis.