Archive for Stock Research

The Guide to Understanding Financial Statement - How to Read a Financial Statement

Income statements and balance sheets are two common annual financial statements. These reports contain information about a company’s performance that year and present a snapshot of the health of the company at a given point in time. Publicly traded companies are required to file them to the SEC and they are available to the public through EDGAR. Understanding the information contained in them can help an investor make better decisions. An income statement will always contain figures for revenue, cost of goods sold (COGS), selling, general, and administrative expense (SG&A), and earnings.

Revenue is gross income. It is the total income before any deductions are made for taxes, etc. COGS is the cost of purchasing raw materials and production costs. This is where accurate inventories are important because COGS equals the beginning inventory plus the cost of produced goods during the previous year, less the previous inventory. COGS figures show the cost of producing goods. These costs can show how well managed a firm is. SG&A expenses are the sum of salaries, commissions, and traveling costs for management and salespeople, advertising costs, and payroll costs. These figures also need to be controlled by management because, if they get out of control, they affect the profitability of the firm. Finally, earnings are the company’s revenue less expenses (COGS, SG&A, and taxes).

On the income statement these figures are easy to see because they are labeled just as described. Sometimes firms may refer to COGS as cost of sales, however.

The balance sheet is a snapshot of the firm’s health at a given point in time. The balance sheet has two parts: assets and liabilities. Asset items on the balance sheet are listed in the order of their liquidity or availability for use as company funds. Commonly listed asset items on the balance sheet are cash, accounts receivable, current assets, and fixed assets. We all know what cash is. Accounts receivable are debts owed to the firm. Accounts receivable are a current asset in that they are expected to be converted to cash within the year. Other current assets are cash, inventory, marketable securities, and prepaid expenses (rent, for example). Fixed assets are depreciated over time and are tangible, long-lived resources like plants and machinery. Liabilities are current liabilities (debts owed within the year), long term debt (payments over years), and equity (total value of shares owned by shareholders).

What’s most important to investors about the balance sheet is the book value of a stock can be determined from these lists of assets. Stockholder equity, or book value, represents the amount shareholders would theoretically receive if a firm went immediately out of business. Market value of the company is generally higher as firms do tend to make money. How much higher this market value is can help the investor determine if a stock is overvalued or, perhaps, undervalued.

Stock Investing for Dummy - What are Operating Expenses, Operating Income and Operating Margin?

All three of these terms have to do with the overall health of a company’s operations and the ability for it to continue as an ongoing firm. These figures are best studied over a period of time against competing firms within the market sector of the particular firm.

Operating expenses are part of the overhead costs attached to selling products on the market. They are not necessarily directly connected to the cost of the specific product being sold but must be included when figuring the operating expenses of a company. These include fixed costs of salaried employees (administration, sales, etc.) and variable costs (labor, research and development, etc.). Operating expenses are found on the income statement.

Operating income determines a company’s earning power from ongoing operations. This is the figure equal to earnings before deduction of interest payments and taxes. This is another figure commonly found on the income statement. This figure is also commonly referred to as operating profit or earnings before income and taxes (EBIT). Operating income is a direct result of a company’s efforts to turn a profit.

Operating income is required to determine operating margin along with net sales. Net sales is another figure that can be obtained directly from the income statement. By determining operating margin we can know the proportion of a company’s revenue that is left over after paying for variable costs of production (labor, raw materials, etc.). This figure helps the investor know the overall health of the company and how well managed the firm is. A firm must have a healthy operating margin to pay for the fixed costs involved in doing business like interest on debt. Operating margin is most valuable when tracked over time and compared to the operating margin of its competitors within the same market sector. Companies competing in different market sectors have different cost structures, of course.

101 Stock Market Investing - How do you find the “Industry Beta”?

Beta is the measure of how a stock’s trading price moves compared to the market as a whole. Knowing this figure one can understand how volatile a stock is. A beta of 1 means a stock’s price fluctuates exactly as much as the market. A beta less than 1 means a stock is less volatile than the market and a beta greater than 1 means that stock is more volatile than the market.

Betas can be determined for entire industries also. The “industry beta” would compare the volatility of the industry relative to the whole market. For example, technology stocks tend to be more volatile than the industry so the beta would be more than 1, generally.

To calculate industry beta you need some historical data of the price of the industry stock and historical price data of the entire market. For example if you were going to calculate beta over the last year for compare technology stocks versus the S&P 500, you would first gather the historical data you need. Next, determine the movements of the two prices after each trading day. This will give a percentage change versus the previous day. Once we have 365 of these we can average the group to determine the average move each made over the last year. We can call the average industry movement Ri and the average market movement Rm. Finally, divide the technology industry’s average movement by the S&P’s average movement and we will have an outcome that is less than 1 (less volatile), 1 (equally volatile), or greater than 1 (more volatile). Written out this function looks like this:

Β = Ri / Rm or B = Covariance(Ri , Rm)/ Variance(Rm)

Beta can be useful in stock research when judging how risky a stock is versus a stable investment with a guaranteed rate of return. It must be noted that the longer period of time the beta is acquired the more accurate that beta will be. Also, betas are more valuable when used with stocks that have a long record of high volume trading. Smaller stocks that don’t trade a lot can fluctuate wildly on a busy day and throw the beta out of whack for the period being measured.

Stock Dividend Record - What is a “Dividend Record” Where can I find it?

Standard & Poor’s (S&P) Dividend Record provides comprehensive information on dividend payments and corporate actions of over 22,000 equity securities. It is available through S&P’s Data Services for a fee. S&P is widely accepted as the world leader in independent investment research. The information focuses on cash and stock distributions and consequences these will have on taxes. Mergers and acquisitions affecting dividend payments, redemptions, outcomes of stockholder meetings are also detailed. Dividend Record focuses on companies listed on American and major Canadian exchanges, as well as selected foreign stock issues.

The information is accessible through the Internet direct from S&P. Information from Dividend Record can be used to research individual companies, market sectors, market indices, or the market as a whole. Emerging trends can be studied from the data. Even though the information isn’t free, reports about the latest Dividend Record are widely reported every time the quarterly versions are published.

Mergent also publishes its version called, appropriately, Mergent’s Dividend Record.

Another use of the term “dividend record” has to do the date a company actually makes announced dividend payments. This record date is important because shareholders on record on that date will be paid. For example, a company would announce that it will pay a dividend on April 1 to shareholders on record as of March 15.

Weighted Average Cost of Capital (WACC), Historical Commodity Prices, Index Prices, and Country Risk

The Weighted Average Cost of Capital (WACC) is a calculation of a company’s proportionately weighted capital according to specific categories. All sources of capital – common stock, preferred stock, bonds, and any other debt are included. It’s computed by multiplying the cost of each capital source by its proportional weight (% of total capital) and then working through this equation.

Where:
Re = cost of equity
Rd = cost of debt
E = market value of the firm’s equity
D = market value of the firm’s debt
V = E + D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate

The WACC is useful in determining how a company gains its capital. Is it financing itself through debt or equity? The WACC helps answer that question. Computing WACC offers insight into a company’s ability to make returns upon its investments and, hence, money for investors. The WACC is often used by internal management to steer the company toward beneficial, moneymaking projects and away from losing ones.

A historical commodity price index will illustrate prices of a commodity at specific historical times. Over a given period of time the average of these indexed prices gives the commodity’s historical price. Speculation on future commodity prices can be made on fluctuation’s of the commodity’s historical price. The spot commodity price is the price of a commodity “on the spot” where it is being sold on the cash market.

Index closing prices are the numbers we hear given on nightly news broadcasts. The NYSE index and NASDAQ index are both examples of whole market stock indices. The Dow Jones Industrial Average and the S&P 500 are examples of broad-base stock indices. The prices of these broad indices are determined by using the closing prices issued by the primary exchange for each member stock in the index. If the price changed during the trading day, the new price is used to calculate the index closing price. Thus, with the S&P 500 calculations of price fluctuations for all 500 member stocks each day are made to determine the daily index price.

Country risk rates reflect the risk of investment in that country. Government stability, both political and financial, factor into this heavily. Banks may use this term to determine whether or not it wants to provide financing to a company that does a lot of business overseas. The magazine Euromoney puts out a survey of country risk and ranks them.

US Securities and Exchange Commission (SEC) Filings & Forms (EDGAR) - Using EDGAR

Securities and Exchange CommissionSome of the most important information to the investor can be found on EDGAR, a free web site run by the Securities and Exchange Commission (SEC). Every publicly traded company is required by law to file detailed financial statements to the SEC including annual financial statements (form 10-K), quarterly financial statements (form 10-Q), and other forms dealing with the inside transactions of a company’s management.

All of these statements are freely available on EDGAR. A quick tutorial on using EDGAR is available on the home page. I’ll go through a quick overview in finding the most recent annual report for Disney. From the EDGAR home page, click on the ‘Search for Company Filings’ link. From this page you can see there is a lot of information available for company filers. One could go about several ways to find Disney’s latest yearly financial statement; I’m going to click on ‘Companies & Other Filers‘. In this entry box we could search by Company name, CIK (ticker symbol), file number, state, or SIC (Standard Industrial Classification). As you can see, a lot of information is available here at the click of a button. You could find all the financial statements filed from companies incorporated in the state of Arkansas by typing AR in the State/Country box. But I digress; let’s get back to finding Disney’s yearly statement. I’ll type Disney in the ‘Company name:’ box and click ‘Find Companies’.

In the results page there are several returns under the name Disney. I can see that there are two listings for Disney Enterprises Inc. I click on the CIK link next to the first one and find that it deals with older filings before 1996. I’m interested in the most recent 10-K filing so I’ll go back to the results page and click on the CIK link next to the second Disney Enterprises Inc. listing.

Finally, I’ve arrived at the results page. Another search form is available to further drill down the results. I’m looking for form 10-K, so I’ll type that in the box and click ‘Retrieve Filings.’ Now I have only the results I desire – form 10-K from 2006 and years prior. Disney’s fiscal year ends 9/30 so they’ll be due to file another 10-K within 60 days of that date.

Stock Market Trading Tip - Which companies do I choose? How do I know which sectors will do well?

An investor can use a number of criteria when determining a sector from which to select prospective stocks. However, it is important to do your own sector research to avoid becoming trapped by “professionals” who have vested interests in the sector they are promoting. So, ask yourself, is the stock in a sector that you think will do well? What are your reasons for thinking this? Answer those questions with careful research before selecting stocks within the sector for prospective investment.

P/E (profits/earning) ratios are most helpful as a prospective tool when comparing stocks within the same sector. Stocks competing within the same sector have similar expenses and expectations. With the P/E ratio the general rule of thumb is the lower the ratio the sooner stock prices are expected to rise. The P/E ratio represents the stock valuation of the company.

Now that you’ve selected some companies you wish to research further, you should be able to answer the following questions:

How has the company performed so far? Is the company growing regularly, from year to year?

How much cash does the company have available? Having cash available details the company’s ability to pay its bills and generally can determine how well managed the company is. Look at financial statements that are required by law to be filed with the SEC.

Look at the volatility of the share price. Have there been wild fluctuations? Compare charts over different periods.

Finally, determine if the prospective company is geared for quick gains or as a long-term investment. Answering this question may have to do with the type of investor you are personally.

Once you’ve done the research you should be able to determine why you want to select a stock for investment. You can invest with confidence, knowing that you have the research to back up your prospects. The better-informed investor makes better decisions.