Getting Started in Emerging Markets af Christopher Poillon Getting Started in Technical Analysis af Jack D. Getting Started in Online Brokers af Kristine DeForge Getting Started in Project Management af Paula Martin og.
How Fundamental Are the Fundamentals?
This book is not just an introduction to the set of analytical tools collectively known as fundamental analysis—it is more. Combined visual and learning tools—numerous practical examples, definitions in context, key points, checklists, and graphics—take obscure concepts and translate them into real-world action in a way that relates to the same decisions you face as an investor every day.
Financial Statements and What They Reveal
Financial Statements: A Starting Point
Financial Statements and What They Reveal. fundamentals'', formal statements are a central part and anyone starting to pick stocks should be able to read these statements. Averaging information over time is necessary because it is difficult to assess a trend at this point in time.
Moving Averages—In Various Forms
However, fundamental analysis benefits equally well from using the moving average in its various forms. Weighted Moving Average Example You are examining an array of five values, as in the previous example.
Balance Sheet
Although these are not technical liabilities, they are listed in this section of the balance sheet. The way in which the double-entry bookkeeping system records transactions—with anything involving a debit and a credit—bal-.
Statement of Operations
The "operating" profit or loss is distinguished from true net income, which takes into account other, non-operating income or expenses (see below). Net profit is the "bottom line", the net remaining after other income and expenses have been deducted from operating profit.
Statement of Cash Flows
The second part of the cash flow statement summarizes changes in current assets and current liabilities for the period. The areas and organization of the cash flow statement are summarized in Figure 1.4.
Comparative Financial Statements
When this happens, it is difficult to assess the results of each division when a consolidated statement is all that is offered. The operating profit or loss is adjusted for the net difference, resulting in the total net profit.
Footnotes
In fact, accounting rules in the United States are so complex that it is possible to manipulate the numbers to achieve a desired result without committing outright fraud. But in fact, the main developer of one of these theories – the Dow theory – originally developed his ideas for application in finance.
Basic Stock Market Theories
All too often, new investors are thrown into the mix without getting a broad view of how the market works (or at least how different people think the market works). As a result, these newcomers are bombarded with various conclusions about the market without being told how and why these ideas have value.
Comparisons between Fundamental and Technical Analysis
Technical analysis is based on a study of patterns seen on charts and the trading ranges they reveal. A stock's trading range is the distance between high and low prices, demonstrated over time.
The Value of a Combined Method
In the market, your best guess—based on the use of fundamental and technical indicator information—is far better than mere guesswork. The share price, whether today, yesterday or in the future, has nothing to do with the value of the company as a long-term investment.
The Dow Theory
The DJIA is interesting to fundamental investors as a reflection of the Dow Theory because the same principles underlying this theory can be applied to the fundamental side as well. The Dow Theory is so institutionalized as the market's leading indicator—even with equal news coverage given to the S&P 500 and NASDAQ indexes—that most people consider a point change in the DJIA to be representative of the entire market.
The Random Walk Hypothesis
A comparison between the Dow theory and the random walk hypothesis is interesting because they are opposites in many ways. Just as the random walk is unlikely based on historical data, the efficient market theory is equally questionable.
Theories about Risk
Stock A's price rose 6 percent, and Stock B's price rose 9 percent; in other words, Stock B far outperformed Stock A. However, there are many different types of risk and each must be evaluated as part of the overall investment decision.
Markets Matched to Risk Tolerance
Inflation risk relates to the risk that inflation - the loss of money's purchasing power - will offset some or all of the profits you earn from your investments. In the next chapter, you'll see how the basic information you find about companies—audited financial statements—is collected and presented.
The Audited
Statement—Flawed but Useful
In Arthur Andersen's case, no central control was put in place to prevent abuse; on the contrary, the rule in the company was to increase revenues decentralized. You can rely on audited accounts, but not as completely as before.
How Audits Are Really Conducted
You cannot fully rely on the audit process or the objectivity of the audit firm. Even with new laws designed to eliminate audit firms' conflicts of interest, it's all too easy for firms to circumvent the rules.
How GAAP Works
However, even with changes in the law on how audits are conducted, there has been little improvement in the problem since his statements. Investors cannot answer solely on audited financial statements, but must look beyond the columns of numbers to the disclosures in the notes to the financial statements.
Disclosures in the Footnotes
These notes can be over 100 pages in many cases, so they can be daunting – the good news is that you don't have to read them all. Domestic and international sales of Philip Morris are the largest; but the company also owns Kraft Foods, which is one of the largest food corporations in the world with dozens of brands.
The Sarbanes-Oxley Act and Auditing Safeguards
Previously, the accounting industry was self-regulating; but history has shown that this was not effective. The industry's complete failure to regulate itself alone points out how little investors can trust audit independence.
The Corporate Scandals
The new law and even the enormous fines did not change the way Wall Street firms operate. The record comparing buy and sell recommendations from major Wall Street firms highlights the intrinsic nature of the problem.
Why Audited Statements Do Not Tell the Whole Story
The point to emphasize here is that you cannot rely on audited financial statements for answers. Audit firms that work for these companies do not protect investors by revealing the kinds of issues that you should be concerned about.
Core Earnings Adjustments
In the case of the misleadingly created working capital scenario, it is questionable whether an accountant would include an honest explanation in the footnotes to the financial statements. Reporting basic earnings leads to another problem:. the reporting of core assets, which is the company's real net worth including all liabilities.
Finding Financial Information Online
Step-by-Step Explanations
Selected Corporate Websites
The easiest way to find web addresses for companies is to refer to the free online sites or to do a web search on the company name. All listed companies on the major stock exchanges can also be linked directly from the stock exchange's website.
Finding and Interpreting Key Facts
As a quick checklist, this is by no means a definitive fundamental analysis program; it's just a starting point. As a result, it is impossible to determine the long-term trend because it has not yet been established.
What Selected Financial Information Reveals
So many investors choose companies because they like the product without considering the company's relative value as an investment. It is a sham game and most corporations that played it ended up losing money and many even declared bankruptcy.
What Is Left Out of Financial Statements
These liabilities are probably not recorded on the financial statement of a corporation and can only be found in the footnotes. Footnotes will disclose any contingent liability of this type, but they are not highlighted in the financial statements.
How to Ask Questions
A more subtle approach is to change accounting methods so that some of this year's expenses are moved to a previous year. Many people simply ignore repeated statements from the past, but this opens up possibilities, especially for the creative accountant: increasing this year's profits by moving expenses back in time to the previous year.
How Accurate Are the Numbers?
Some believe that it is acceptable to carry forward profits, but not to exaggerate this year's profits. But even if this is an accurate finding, it is no justification for moving profits forward.
Some Accounting Principles
Accruing Transactions
Remember that the purpose of making journal entries is to reflect current income and costs and expenses in the correct period. So two-thirds of the payment will be set up as a prepaid expense and reversed in the following year.
The Basic Reporting Problem
Inaccuracy
Long-term results are what demonstrate whether a corporation is able to manage its business results and markets. With new federal laws making such fraud more difficult, it's less likely.
Why Year-to-Year Comparisons Are Difficult
The sell-off year reported lower-than-usual earnings for Miller Brewing because the unit was sold in the middle of the year. For example, in some industries, gross profit (revenue minus costs, profit before expenses) can be quite high.
Complexity versus Fraud
Like income, expenses are supposed to be reported and recognized in the applicable accounting period. The balance sheet is supposed to be a complete summary of all of a corporation's transactions and, in the case of the balance sheet, of all of its assets and liabilities.
Core Earnings as an Analytical Tool
Adjustments to base earnings can be quite significant, distorting results from one year to the next, making all fundamental analysis unreliable. In general, you will find that companies that are well managed will tend to have a lower amount of base earnings adjustments each year.
Confirmation: The Trend of the Trends
The Dow Theory and Confirmation
This apparent signal can be confirmed if the stock price tests the resistance level (at the top of the trading range) two or more times without success. An indication based on a change in an index can be confirmed by a chart pattern in the stock.
Using Technical Tools in the Fundamentals
With this news – confirming that something didn't make sense based on your relationship tracking – you decide to cut your losses and sell. Based on the justification for acquiring the company and on the stated long-term growth plan, you decide that the apparent problem is transition time—you are not selling.
Confirming Both Good News and Bad News
You must become adept at finding information in footnotes and determining how important they are. It is clear that the accounting rules leave much to be desired, not only in what is not included in the statements, but also in the way that full explanations are not provided.
The Problem of Time and Fundamentals
It is constantly updated and for many investors it serves as one of the most important decision points. When a corporation reports consistent sales growth and net return, it is a reliable long-term indicator.
Confirmation to Help Avoid Misreading the Trend
Even if the last statement is outdated, the long-term trend is reassuring; and by checking the latest financial news about the corporation, you can gather up-to-date revenue and profit numbers, even if these are only indicative. For example, a corporation has reported large net losses for the past three years, but its current ratio remains strong.
Common Mistakes and How to Avoid Them
This is a danger sign, a sign that management has relaxed internal controls during the expansion period. In the next chapter, you will begin to see a methodical interpretation of the actual ratios that become the building blocks of long-term trends.
Balance Sheet Ratios
Making the Analysis
These include values in at least three different formats: balance sheet reports, income statement reports, and reports that combine fundamental and technical information. The balance sheet summarizes the values of assets, liabilities and net worth until the end of a fiscal quarter or year; so most balance sheet reports involve testing and analyzing same date values.
Current Assets and Liabilities
During periods of exceptional growth, there is a tendency for both receivables and inventory levels to increase. So when you're testing current accounts and their ratios, look for trends in working capital, including trends in accounts receivable and inventory balances.
Working Capital Tests
Testing relative accounts receivable levels is revealing, especially during times of revenue growth. The comparisons you make between accounts receivable and revenue or income must be done over a number of periods.
Capitalization: Debt and Equity
This decision has negative long-term consequences and without the debt ratio it can be invisible. In a very real sense, the declining availability of future working capital - brought about by ever-increasing long-term debt - could mean lower future dividends.
Ratios between Balance Sheet Periods
You also have to consider that shareholders in this company have to pay back the long-term debt accumulated at the expense of equity capitalization. You can review revenue and gross profit by operating segment; however, for any long-term trend analysis that includes operating results, you will need to review trends for resets.
Off-Balance Sheet Liabilities
In the best-run companies, the notes are clearly stated and can even calculate important ratios for you based on the inclusion of off-balance sheet items. There are solutions, but most investors need to do their own work to find out what is going on outside of the balance sheet disclosures.
Income Statement Ratios
Tracking the Profits
Although these terms have some distinctions, they are often used interchangeably in relation to the income statement. For example, return on equity is another ratio that compares profits to dollar amounts outside the income statement.
How to Spot the Key Trends
You must also be aware of the differences between operating profit and profit before tax. When costs and expenses are subtracted from revenue, you end up with the operating profit or net profit.
Insights into Expansion Period Trends
If collection control is relaxed during periods of growth, bad debts will increase and the company will start writing off more bad debts. Every management team makes mistakes, and even during periods of expansion, large net losses can result.
Relationship between Revenues and Net Earnings
So even in the most successful case, and even when companies employ all of the above methods to create and continue revenue expansion, there is a natural limit. The independent franchises of the past are now found in growing numbers in larger stores or opened in combination with other franchises.
Important Ratios
Despite reported high profits of $8.317 million in the September quarter, the company's revenues and profits have been declining over the past four to five years. Another, more likely problem is that the company has poor internal controls, which continues to increase costs.
The Popular P/E Ratio and How to Use It
Development of the P/E
The number of shares used in calculating EPS can further distort the P/E value. However, if you study an annual range over many years, you will get a better idea of the price-to-earnings ratio.
P/E Adjusted for Core Earnings
Earnings per share are then compared with core earnings per share, as shown in Figure 9.3. Although the difference in earnings per share based on net income and core earnings per share in this example is not significant, it could be.
The P/S Ratio
For companies with unusually large underlying earnings adjustments or significant volatility in reported earnings, the P/S ratio is particularly useful, especially as a confirmatory trend. In these cases, bottom line confusion can be cleared up by a downward trend in the P/S ratio.
The P/B Ratio
This is an adjustment to the book value per share, subtracting intangible assets from total net assets. When comparing price to book value, remove intangible assets from total assets to ensure accuracy.
The P/C Ratio
The ratio can have extraordinary value in certain types of industries, where the use and generation of cash has a lot to do with the generation of profits. The P/C ratio is therefore valuable in these types of companies, assuming that the related account values (especially short-term and long-term loans, and the balance between cash and investments) remain fairly stable from year to year.
Historical Trends and What They Reveal
If an investor was considering buying Citigroup and a key concern was volatility in price and fundamentals, these types of long-term range tests would be reassuring. P/S is particularly useful for overcoming high volatility in adjustments to base earnings or for tracking growth trends in companies that report years of net losses as well as years of net gains.
Using Fundamental—
Volatility as a Measure of Market Risk
If the price has been declining over the past year, does this also confirm weakening fundamentals. Investors expect some certainty in the price trend, so high volatility without much price change can be a danger signal in terms of market risk.
Employing a Combined Program
