Updated: Dec 13, 2020
Giving you a better insight into financial statements. Take a look at key metrics relating to this companies financial statements over the last 9 year. Gross profit margin, Expenditure to earnings, the important ones are covered here in a realy easy to view way using graphs to help you spot trends.
I will be looking at what I consider to be the key areas of this company's financial statements over the last 9 years. Please bear in mind that this is not financial advice and you should not base your trading/investing activity off of it, always do your own research before investing.
Gross Profit Margin
We want to try and identify companies with consistently high Gross profit margin, as this could indicate a company with good economics over the long term that may be working in their favour. Companies with volatile or consistently low gross profit may be struggling, but ultimately this changes depending on industry and ideally this should be used to compare with other companies like it.
Sales, General & Administrative
Again when it comes to trying to find a company with a "durable competitive advantage" (as Warren Buffett refers to it), consistency is something we like to see. Companies that have volatile SGA which fluctuate a lot tend to be companies suffering from intense competition. Also if SGA costs are high, that means the company is eating away at its gross profits. Generally speaking, the lower the SGA costs the better, and the less volatile the better still.
Depreciation to Profit
As machinery or equipment cycles through its expected life span, its value decline is recorded by a company as depreciation. For example, if a piece of equipment was purchased at $1 Million and is expected to have a life of 10 years, the company will record that as a $100,000 depreciation per year. What we want to look for then are companies that have lower depreciation costs when compared to profits. This indicates to us that there is a likely internal efficiency, as well as a probable reduced need to constantly replace machinery.
R&D Spend to Profit
Companies with a competitive advantage achieve that advantage somehow, either through some technical process or by patent for example, and it usually costs a lot of money to do so. However some companies are able to hold their advantage easily while others constantly have to pour cash into staying ahead or catching up. So companies that have to constantly spend large amounts on R&D could be seen as companies in a highly competitive environment. For these companies it may not take much to lose their lead and this is especially try of certain industries such as auto makers or tech. So what we would like to look for (ideally) is a company that doesn't need to spend a great deal of its profits on R&D.
Interest to Profit
Interest paid out on debt; when compared to profit, gives us an idea of how affordable the interest payments for this company are. If a company is paying a lot of interest compared to its profits, it can spell danger. So to find a company that can easily afford its payments, we want to see this ratio as low as possible. Personally I like to see anything under 10% of profits go to interest payments. Anything under 6% would be great and no payments what so ever i.e. no debt, would be fantastic.
Net income shows the amount we have left after expenses and taxes have been accounted for. Obviously we want to see a positive figure here, but also, we would like to see consistency. If there is a gradual upward trend over the years even better.
Earnings to Revenue
This metric compares net income to revenue. This is useful in showing us how well a company is able to make money. If their earnings are only a tiny part of revenue, that means a large amount of money is lost in operating expenses, interest payments or tax for example. So ideally we would like to see an earnings to revenue ratio above 20%. What's more we also want to see that consistency.
Cash and cash equivalent's refers to liquid assets that the company holds. These are usually cash and bonds. As this asset is highly liquid, it can be used very quickly. However it also doesn't do much. A bit like having uninvested cash in your broker account, it is beneficial to have but also not ideal if you have a very large sum just sitting doing nothing or very little. Personally I like to see a level of cash that goes somewhat towards current liabilities (in the region of around 0.25)
Current ratio is a popular metric used by analysts that takes all current assets and compares them to current liabilities. If this number is 1 or above it indicates that all assets that can be liquidated with a year (current in accounting terms usually refers to a year period) are equal or greater than all the current liabilities. A company with a ratio lower than 1 may be in a tight spot when it comes to whether they can afford their liabilities (which include things such as short term debt payments, tax, payable invoices etc).
Short term debt to Long term debt ratio
Short term debt refers to money the company borrows that needs to be repaid in 1 year. Companies that borrow a lot of short term debt tend to be at the mercy of sudden economic changes. A lot of banks have spelled disaster for themselves by borrowing too much short term debt. The safest way to borrow is to borrow long term, so we like to see a company with little short term debt in comparison to long term.
Long term debt to equity
This is a simple metric which shows how much debt the company has in relation to their net worth. If this figure is close to 1 that would indicate that the company may be borrowing too much and may be considered a risky company.
Short term debt to equity
Is essentially the same as long term debt to equity. A higher ratio may pose liquidity concerns for this company.
Years to pay off debt
This metric compares long term debt to net earnings. It looks to give us an idea of how long it would take the company to pay off its long term debt using net earnings. Warren Buffett has historically chosen companies that could pay off their debt within 3 or 4 years.
After net earnings a company has a choice, it can pay dividends with its earnings, buy back shares, retain its earnings to help grow the business, or a little bit of each. In general, the more a company adds to its retained earnings, the higher its growth rate for future earnings will be. An increasing pool of retained earnings is a show of strength as well as advantage. Therefore we would like to see a steady increase in retained earnings over the years. If there is a sudden dip in this, we need to ask why.
When a company buys back shares, it can either cancel those shares or it can retain them. Great companies with plenty of cash like to buy back shares, so we would very much like to see an increasing amount of treasury stock (this is held as a negative number on the balance sheet, so we are looking for the negative figure to increase i.e. -$100 becomes -$200. For our graph we decided to convert treasury stock into a positive figure, therefore when looking at this graph you should be looking for a steady increase over time to the up side.
Return on shareholders equity
This is the value we get when we divide net earnings by shareholder equity. In our calculation we also account for treasury stock so the calculation is Net earnings divided by the total sum of shareholders equity and treasury stock. As a general rule, we want to see a company that is able to generate high returns. If returns in this metric are consistently low, I would stay away. What we would prefer to see are consistently high returns.
Expenditure to earnings
If capital expenditures remain high they begin to have an impact on earnings. A stable, well run business will tend to have low expenditure compared to earnings. So we would rather look for companies like this than companies that constantly require huge amounts of cash to operate. If a company is using close to all its earnings on capital expenses it spells trouble. What we would prefer to see then is a company ideally using less than half its earnings. Anything less than 25% I would consider to be very good indeed.
Don't miss an opportunity
Discover this stock in our screener spreadsheets
And find out if it is trading under or above its 200 day average, as well as: PE ratio, Earnings yield, market cap and more.
So now that we have reviewed some of the key metrics for this company, why not comment below and let us know what you think about this company. As always, you should always do your own research, and I would recommend if you like this content and want to analyse financial statements in this way, that you read the book linked below.
Source of financial data: quickfs.com