4 keys to better stocks investing

Many of us want to invest for many different reasons. Some want to make money through buying stocks, others think that the bank's interest rates are too low so they seek to find ways to earn more interest. In other words, the trigger point for most people to invest is making more money. Those who're not interested in making money may never even think of investing in the first place. There are a few exceptional cases where investing is taught at home. Warren Buffett is one of them where his father was a stock broker so Warren Buffett was exposed to the world of stock market at a very young age. He went on to have many mentors such as Benjamin Graham and Philip Arthur Fisher who taught him the essence of value investing.

But for most of us, we're not so fortunate to have people to guide us on investment. Many of us put our hard earn money into stocks without much knowledge. In an effort to make more money, we instead lose money then start learning through the hard way. It seems like a natural process which every investor has to go through before succeeding.

However, if you're a new investor and want to start investing, today i'll share 4 keys you need to know before you start investing. Hopefully this will reduce your risk and make your investment journey a smoother one.


1) Financial ratios do not make sense if you don't understand it

Many new investors try to find the holy grail in investing. They learn a few financial ratios such as PE and PB ratio then try to find out at what levels to buy a stock. PE ratio below 10 means buy? PB ratio below 1 means buy? All these do not make sense unless you understand the concept behind these ratios. Try to understand the ratios instead of relying on a fix number to invest.

2) Understanding how a business operate is important

Investing is not about gambling or buying blindly. You need to know how a business generate its profit. If you can't figure out this source, don't invest in that company. If a business can't generate profits, then putting your money into that company is highly risky. 

3) Know the financial health of a company

Is the company spending too much or borrowing too much money? We know that as individuals, if we spend more than we earn, we'll run out of money one day. If we take debts more than we can handle, we may go bankrupt one day. It is the same with a business. A company which is spending more than it earns or borrows too much money is the one you should avoid investing in.

4) Learn the language of business

The language of business is accounting. I cannot stress enough the importance of accounting knowledge in investing. Do you know how to read the 3 financial statements namely the income statement, balance sheet and cash flow statement? Do you know how to refer to the notes to the financial statement to look deeper into each individual entries?

For example, the revenue in the income statement will show you how much money the company made selling its goods and services. However, to know where the revenue comes from, we can refer to the notes to see the breakdown of revenue from different sources.

Let's see an example from Breadtalk's financial statement. In 2013, Breadtalk's revenue was $536,530,000 as seen in the income statement below.

Adapted from Breadtalk 2013 Annual report

Click to enlarge

To see the breakdown of the revenue, we can look at the notes to the financial statement at the back of the financial report. It is indicated as notes 3 so this gives us the exact page to go to. Below shows how the notes look like.

Adapted from Breadtalk 2013 Annual report

Click to enlarge

From the notes to the financial statement under 3, we can see the revenue breakdown. The entries recorded are bakery sales which supposedly is from its Breadtalk bakery, restaurant sales from its Din Tai Fung, Ramen Play and other restaurants which it might have, sales to franchise, franchise income and lastly its food court income from its food republic. Now we know where most of its income comes from which is from its bakery sales. It's food court income comes in second. 

There are many more interesting things we can find from a business if we understand the language of business which is accounting. The good news is accounting can be self learnt and as investors, we don't have to know everything. We just have to know a few key stuffs. Hopefully, the 4 keys above will guide you to the right track in your investments. Understanding how to invest makes it more interesting than just investing without knowledge. Remember, as a shareholder, you own part of the company. An owner will want to know what is happening in his or her company.

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Related Posts:
1. Understanding financial statements (Part 1) - The income statement
2. How to pick stocks (Part 2) - The profitability of a business

Understanding Financial Statements (Part 3) - The Cash Flow Statement

The cash flow statement is the 3rd and the last of financial statements you can find in a company's annual report. The other 2 statements are The Income Statement and The Balance Sheet which we have discussed earlier.

The cash flow statement is one of the most important among the 3 financial statements. It shows the actual cash the company has generated and removes all the non cash items which you see in the income statement such as depreciation.

The Cash Flow Statement

The cash flow statement is divided into 3 parts:

1) Cash Flow from operating activities / Cash from operations
2) Cash Flow from investing activities / Cash from investing
3) Cash Flow from financing activities / Cash from financing

You can access a sample of Singtel's Cash Flow statement here. You can refer to this as we go through the cash flow statement line by line. Let's start.


Cash from Operations
First up is the cash from operations section. This section shows you how much cash the company has generated from its business. This is an area you will focus on more when evaluating a company as it will tell you how effective the company is in terms of generating cash from its business operations

Net Income
Firstly, on the top line of the cash from operations section, we have the net income. This figure is simply taken from the income statement.

Depreciation & Amortization
Next we have the depreciation & amortization. Depreciation is the drop in value of assets of the company over time. However, just because the assets drop in value doesn't mean the company pays for the loses. No cash is being transferred out. Thus, this is added back to net income.

Changes in working capital
The next few items we see are all part of changes to working capital. The first 4 items are quite straight forward which i will not discuss here. The 2 important ones here are changes in accounts receivables and changes in accounts payable. Recall that this 2 items are found in the balance sheet also. Accounts receivables is what the company expects to receive which it hasn't collected yet. Accounts payable is what the company owes to others.

If accounts receivables is lesser this year compared to the previous year, it will be a positive figure in this years cash flow statement. This means that less people are owing the company thus the company receives more cash this year. Remember, only real cash items are recorded in the cash flow statement. This is the actual cash which the company receives.

For accounts payable, it is the other way round. The more you owe to others, the less cash you have to pay up this year. This means that you have more cash stored up for this year and it will be a positive figure in your cash flow statement.

Cash from operations
Adding up and subtracting all the items above, you get your final figure of cash the company has generated from its operations. This is an important figure to note.


Cash from investing
Let's move on to the second portion of the cash flow statement. These are activities which involve the acquiring or disposing of property, plant and equipment (PPE), corporate acquisitions and any sales or purchase of investments.

Capital Expenditure
The first entry is the capital expenditure. This is the expenditure on property, plant and equipment. Basically any expenditure to keep the business running. Cash from operations minus capital expenditure will give you what is known as free cash flow(FCF). FCF is the amount of cash the company generates after investing in its business.

Investments
Other entries inside are some investments the company has made for example cash acquisitions of other companies, investments gains or losses from bonds or equities etc. Adding and subtracting the above items you'll get the final figure of cash from investing.


Cash from financing
This is the final portion in the cash flow statement. This part records any transactions between the company's owners or creditors.

Issuance & repayment of debts
The company can borrow money by issuing debt in the form of bonds. This portion shows you whether the company has borrowed more money or repaid debts it previously borrowed.

Issuance & purchase of common stock
This is an important number to note also. Companies can issue more stocks to raise capital for expansions. However, issuing more stocks/shares can dilute the existing shareholders worth in the company.

On the other hands, companies which has cash and are slower in expansion, can buy back shares and minimize the dilution for existing shareholders.

Dividends paid
This is straight forward. It just shows the amount of dividends the company has paid.


Conclusion
The cash flow statement is one of the most important of all the 3 financial statements. It shows the amount of cash the company has generated for that financial year. Cash that constantly flows into a company, provides life for it to survive. Thus, the phrase: "Cash Flow is the life blood of any business".

We have concluded this series on understanding financial statements. Knowing how to interpret these 3 financial statements is crucial for your investment decisions. If you know how a company generates its cash and where it makes its money, you'll be clearer on whether is it a good company to invest in?

Of course, the evaluation of a company's business doesn't stop here. After knowing whether it is a good or bad company, we have to know whether the price of the stock of the company which we are buying now is under priced, at the right price or over priced. When we buy things, we like to buy at a discount. For stocks, it is the same concept. We also want to buy a company at a discount relative to its actual price. How to evaluate whether the price of a company is fairly valued is another skill to learn.

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Related Posts:

1.  Understanding Financial Statements (Part 2) - The Balance Sheet

2.  Understanding financial statements (Part 1) - The income statement

3.  How to pick stocks (Part 1) - Economic Moats

4.  How to pick stocks (Part 2) - The profitability of a business

Understanding Financial Statements (Part 2) - The Balance Sheet

The balance sheet records the companies assets, liabilities and equity. Assets is what the company owns and liabilities are what it owes. Equity represents the value of money that shareholders have invested in the company and it is calculated by taking Assets minus Liabilities.

The balance sheet is important in our analysis of a company as it reflects the financial position of a company. The levels of debt and the amount of cash the company has can be seen in the balance sheet. Let's go through the various entries in the balance sheet one by one.

The Balance Sheet

You can access a sample of the balance sheet here. This is Singtel's balance sheet which is the company we used to analyse the income statement in part 1 before.

Current Assets
The first portion of the balance sheet list the current assets. These assets are likely to be used up or converted into cash within one business cycle.

Below shows the entries listed as current assets:

Cash and Equivalents
This doesn't just refer to real cash on hand that the company puts in its safe deposits. It includes money market funds which can be liquidated quickly and short term investments like bonds. These are investment that are less than a year.

Accounts Receivables
These are payments the company expects to receive which it hasn't collected yet. In the previous part 1, we discussed on sales which was one of the entries in the income statement. Companies can record as sales even when payment has not been received. Check if accounts receivables is rising faster than sales?  If it is, it may mean that the company is letting more customers take up loan to buy their products or services. There may be a chance that the payments will not be received in full.

Inventory
Inventory includes raw materials for goods, partially finished products and also finished products that have not been sold. In essence, it includes all the goods from pre production to post production. This is especially important for manufacturing and retail firms. If there are too many goods stored at the warehouse, it may be difficult to sell when recession comes. The firm will suffer heavy a heavy loss as a result. We have to see what goods the company produce. For construction firms, raw materials like steel and aluminium can be kept for a long time and sold for cash in the future. However, for retail firms, the clothing that is stored in the warehouse may not be able to sell at a high price as the fashion trend has already changed after some time.


Non Current Assets
Next is the non current assets. Sometimes they are called fixed assets. These are long term assets which is not expected to be converted to cash within one year or one reporting period.

Below shows the entries in the non current asset rows:

Property, Plant and Equipment
These are the assets which the firms has which includes buildings, factories, furnitures, equipment etc.

Long term Investments
These are investment in longer term bonds or stocks of other companies. The value recorded might worth less or more than the actual market value. Look into the notes to financial statements and see what investments are in this account. After knowing what are the exact investments, you can then decide how to view the amount recorded.

Goodwill/Intangible Assets
Goodwill is used in mergers and acquisitions. If a company pays more than the book value to acquire another company, the difference is recorded as goodwill. This amount can change significantly at times. It does not reflect the actual physical assets in the firm.


Current Liabilities
Liabilities are what the company owes. Current liabilities are what the company is expected to pay within a year.

Below shows the entries under current liabilities:

Accounts Payable
These are what the company owes to others which are expected to be paid within a year.

Short Term Borrowings
These are loans the company take which have to be repaid within a year. It could be short term loans from the bank. It could also be long term debt which is due within the next year.


Non Current Liabilities
Non Current liabilities are debts which are owed for more than a year. There are different entries inside but the most important one is long term debt. These are money the company has borrowed usually by issuing bonds or sometimes from a bank.

Stockholder's Equity
It is also called common equity as recorded in the balance sheet. This is the total assets minus the total liabilities. It represents part of the company owned by shareholders.

Retained Earnings
This is the most important in the stockholder's equity entry. This is the amount of capital the company has generated over its lifetime, minus dividends and stock buybacks. Each year the company makes a profit and doesn't pay it all out in dividends, retained earnings will increase. If a company has lost money overtime, retained earnings can turn negative and renamed as accumulated deficit on the balance sheet.


Why is the balance sheet important?
Companies which have lots of cash and little debt can be more resilient during a crisis than companies who have little cash. Do watch out for companies who have high levels of debt as they can crumble down in an instant when trouble arises.

When looking at current assets and current liabilities, it is generally better for companies who have more current assets than current liabilities. Current liabilities are what a company needs to repay within a year. If there is not enough current assets to cover the amount of liabilities, a company may not be able to continue its operations in the next financial year. This is also known as the current ratio which is current assets divided by current liabilities. A current ratio of more than 1 indicates that the company is healthy. A value of less than 1 is not a good sign and most of the time auditors will flag it out.

Summary 
We have completed the 2nd of the 3 financial statements found in a company's financial report. In the first part, the income statement shows us how much money the company has made. In the balance sheet, it shows us what is the value of the company in terms of its equity. In the last and final statement, which is the cashflow statement, it records the cash that is flowing in the company. It is a more accurate statement than the income statement as it removes the unnecessary non cash items like depreciation and records the real cash items. We'll look into it in the next part.

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Related Posts:

1. Understanding financial statements (Part 1) - The income statement

2. How to pick stocks (Part 2) - The profitability of a business

Understanding financial statements (Part 1) - The income statement

To be an investor, you have to know how to read financial statements. I would say that this is a skill that every investor must know. In fact, Warren Buffet said that the greatest skill a young person can learn during his or her school days is the skill of accounting.

In an annual report, you will basically find 3 financial statements.

1) The Income Statement
2) The Balance Sheet
3) The Cash Flow Statement

I will go through all 3 statements in detail as simple as I can. For this post, we shall use the company Singtel's financial statement as an example. It is the largest company listed on SGX in terms of market capitalization. It is also one of the blue chip stocks and is one of the 30 components stock that make up the Straits Times Index (STI).

Let's start with the income statement.

The Income Statement

I personally use investing.businessweek.com to read up on a company's financial report. You can access Singtel's income statement here. Alternatively, you can get the full annual report from either SGX or Singtel's own investor's relation website.

Revenue
The income statement shows how much a company is making or losing. The first thing we see on the income statement is revenue. It is the sales the company has made for that quarter or year. This is the money it earned through selling a service or product. For Singtel, it can be the selling of mobile phone service which we pay a monthly subscription. The money collected is recorded as revenue. For Singtel, its 2012 revenue was $18.18 Billion

Cost of goods sold
Next, we see the cost of goods sold. This is the cost that is directly involved in creating the revenue. It can be labor costs, raw material costs, or the initial cost price of the goods. This is deducted from the revenue.

Gross Profit
After deducting cost of goods sold from revenue, we get gross profit. Gross profit is revenue minus cost of goods sold. For Singtel, its 2012 gross profit was $5.5 Billion. This is after deducting cost of goods sold of 12.7 Billion.

Selling General & Admin Expenses, Total
Next we see Selling General & Admin Expenses. This is also known as operating expenses and includes expenses such as marketing costs, administrative salaries and research and development costs.

Depreciation & Amortization, Total
The next is Depreciation & Amortization. This cost is the depreciation on assets that the company purchases. Assets like machineries and motor vehicles will drop in value over time. The depreciation reflects the cost of the depreciation.

Operating Income
Another important one we should know is operating income. This is revenue minus cost of goods sold and also all operating expenses. It is the profit the company made from its actual operations. For Singtel, it is the earnings from its main business in the mobile, internet and IPTV services.

Interest Expense/Income
You'll see the next 2 rows being interest expense then interest income. This records the interest the company paid on bonds it issued or the interest collected from bonds it owns.

EBT, Including Unusual Items
EBT means earnings before taxes. A more accurate term you can look at is EBITA. This is earnings before interest, taxes and amortization. You will realise that before the EBT, there is a big chunk of expenses called other non-operating expenses. Accountants may remove this expense and not include it in the calculation towards earnings.

Net Income
This is the company's profit after all expenses have been deducted. It is the income that most companies will report on when they release thier earnings result. However, do note that the figure may be distorted as it includes one time charges or investment income. It does not really reflect on the true operating profit of the company. Investors sometimes look at operating income as it reflects the income earned from its actual operations in the business.

Summary
We have just gone through the various items included in the income statement. In summary, the income statement reflects the income and expenses of the company. For an investor, we do not just analyze a company's earnings power using the income statement only. You'll come to realise that the cash flow statement is a more accurate measure of a company's financial health. Income can be distorted more easily while cash flow is harder to fake. It is the actual cash that flows into the company business.

The next 2 financial statements, namely the balance sheet and the cash flow statement, will be discussed in the next part.

Read the other 2 financial statements below:
2) The Balance Sheet
3) The Cash Flow Statement

Like my Facebook page to receive instant market updates and notifications of new articles. SG Young Investment seeks to educate readers on finance and investment. Join many other readers on this journey towards financial freedom.

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Related Posts:

1. How to pick stocks (Part 1) - Economic Moats

2. How to pick stocks (Part 2) - The profitability of a business