Interpreting Financial
Information
Securities and Investments
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The Annual Report
COMPONENTS OF THE ANNUAL REPORT:
Letter to shareholders
Financial highlights
Charts and graphs
Financial statements
Additional notes
Company information
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Financial Statement
-The Balance Sheet
Provides information about:
– Assets (Property)-current
(cash) and long-term (land,
buildings)
– Liabilities (Loans)-current
(accounts payable), longterm (notes payable)
– Net worth or stockholder’s
equity
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Financial Statement
-The Income Statement
Provides information
about:
– Revenue-income from
sales
– Expenses-operating
expenses such as
salaries, rent, and utilities
– Net income/Net lossrevenue minus expenses
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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.
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What to Look for In Financial
Statements
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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.
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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
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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
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Technical Analysis
• Relies on historical
performance of a
stock in predicting
future success
• Also relies on market
trends
• Supply and demandimportant factors
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Financial Ratios-Liquidity
Ratio
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 AssetsInventory/Current
Liabilities
Similar to current ratio;
subtracts inventory from
assets because they
may not be as liquid.
The higher it is, the
better.
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Financial Ratios-Profitability
Ratio
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.
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Financial Ratios-Debt
Ratio
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.
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Financial Ratios-Operating/Cash Flow
Ratio
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.
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Financial Ratios-Value of
Investment
Ratio
Definition
Price/Earnings
Share price of
A higher number usually
stock/Earnings per share indicates higher growth
relative to the market.
Dividend Yield
Annual dividend per
share/Share price of
stock
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Significance
A higher % indicates a
higher dividend payout
based on the price per
share. Utility companies
typically may pay more
dividends than growth
companies.
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Financial Ratios-Value of
Investment (continued)
Ratio
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.
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Formal Assessments
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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.
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.
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Formal Assessments (continued)
• 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.
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