What can I learn from a company's financial report?


(Eve) #1

One of the posts about doing your own research mentioned looking at company financials. Are there any key things that would point out if a company is doing badly/well on there?
As the blog mentions, it is immensely dry and boring stuff and for people not familiar with it they probably wouldn’t know what to look out for. I tried looking at a few published ones and I think even if they were going in debt I wouldn’t be able to tell from the reports :woman_shrugging:t2:


Ask your beginners questions here 🐣
(Vladislav Kozub) #2

Hey Eve, I hope Alex won’t crucify me but this is the word-for-word question I kept asking myself when started my real investment account back in the days (in 2017 :sweat_smile:) and I believe this is the one every individual should attempt to have some understanding of, so I am going to take this one.

Will start from afar… I originally thought that books are not for me - I needed an easily digestible material in a form of short articles or forum posts. Although my first destination was Reddit (r/Investing + r/StockMarket + r/UKInvesting are very good ones to start with), I did not have the advantage of Freetrade community which by far seems to be the most fit-for-purpose place for beginners to obtain the knowledge and raise questions without risk of being patronised.

Albeit this is not quite related to researching a company’s financials, all of that information forms the overall awareness of how markets generally work, why do certain securities go up or down based on the news, why Utilities companies always rise when all other market sectors go down and vice versa - there are many other little things that all help a lot.

Now getting to the actual research. Whilst Freetrade have covered many aspects in the Do your own research! blog post you referred to, it is, of course, not possible to cover all aspects in one piece. In fact, it is also important to remember that any individual research (like yours and mine) outcome or assumption is probably something that big financial analytics agencies have already established before us. The only difference is that we make our research to understand which type of securities (aggregate name for stocks/shares/bonds/index funds/ETFs/etc.) appeal to us and our risk profile.

For example, you could easily avoid looking at companies’ earnings reports if you are happy with data that is one year old - perfectly fine if you plan to invest (buy and hold) rather than trade (transact while instantly reacting to all the news and press releases) and simply use Stock Screeners.

Stockrow is a very nice one, gives you circa 10 years’ data - just try to type Amazon, for example. Once in, ignore the graph and look at the ratios below: Market Cap, Enterprise Value, Revenue and others. The beauty of it is when you hover your cursor, it will explain what each of these ratios represent and even tell you what is generally “risky” or “acceptable”. For example, looking at Debt to Equity Ratio (since you mentioned debt already), it will say that the value of “less than 1” is considered as a low level of debt, whereas 2 or more - high. Whilst Amazon’s is only 0.70, Tesla’s, for example, is shocking 3.77!

Once you get your head around the ratios, you will realise that if the key ones like P/E, P/B and P/S are positive - most of others will be positive too, meaning good fundamentals.

The next step is trends, which is represented by fancy graphs below the ratios. Constantly rising revenues since 2008 - absolutely great. See many green dots on the graphs? Marvellous! Assets rising faster than debt levels? That is what we need. And all other ones you could look in a similar fashion. Certainly not all of them will be perfect, but it is vital to have key ones in “green”, which are the revenues, the profits and the debts rising slower than the earnings.

Now, the last part is the nature of the business, its long-terms aim and overall purpose. This one is qualitative and cannot be established using numbers only. For example, our Amazon is notorious for its constant growth - they do not pay dividends, they do not make profit - all they are aiming towards is growing and penetrating into other sectors (Healthcare, Shipping, Banking), hence you see their Revenue (the first line) growing 20% every year, and now it is 10 times more than 10 years ago. Therefore, you could immediately discount the importance of P/E (Price to Earnings ratio), because it would contradict the idea of growth. But how would a beginner investor know that? By going back to Step 1 - Reddit, articles, journals, news, Freetrade community - all of these, to some extent, will enhance your knowledge and awareness. Whilst I have only been interested (and have been researching) in markets and investing for a year, I can absolutely see its importance and the abundance of further knowledge that can be acquired going forward. It is a fascinating world, it becomes extremely more interesting once Step 1 is crossed so I absolutely advise everyone to start researching these things at the earliest possible stage.


How I started investing series?
(Rob Sexton) #3

In my previous life as an auditor I spent a lot of time reviewing annual reports, and I sympathise, if you’re not used to them they can be pretty intimidating and opaque.

Different people will have different views on what to look at, and it really depends what you’re after. In terms of understanding the company and its performance (for listed companies), I personally think a good place to start is the financial review (typically by the CFO) and the CEOs review, both of which are narratives. New regulations have driven these towards being more understandable and balanced (I sat in numerous meetings where we challenged management to improve there’s to ensure this was the case) and give a nice overview.

The company’s KPIs can also be a good place to look, as these should help explain what management think are important. I’ve just managed to volunteer myself to do a post in the near future on these, so look out for that! But again new rules in the last couple of years on these measures mean management should be explaining why they’re important, and also how they’re calculated.

If you’re willing to dive into the actual financial statements, it’s always worth looking at cashflow - a big difference between cashflow and profit can be a warning sign (eg Carrillion). After that it really depends on how comfortable you are, which comes with practice, but there is a wealth of information in there, and it’s what analysts use to produce their reports.

Finally, and I’ll admit this is potentially a hangover of my auditor’s bias, but take a look at the audit opinion. They now set out key judgements, which can be invaluable if there’s a big uncertainty in the results.

Hopefully that helps, like I say everyone will have their own view, but I think that gives you a good place to start


(Eve) #4

I think this too, I would have given up on trying to learn the ropes if I had to read a book or dense/dry guide. Reddit has been a really good resource though it’s a bit of a rabbit hole at times. I’ll definitely be making more use of this thread in the future when I can devote more time to doing my own research!

Thank you for sharing and explaining the Stockrow site- it would have taken a lot of Googling to understand those terms. I had a similar question about those odd little thin lines but it has been answered below :sweat_smile:

@Rob would a financial review/ CEO’s report not come across as skewed more in favour of the company, even if it wasn’t performing as well a particular year? I’m not exactly sure how the regulations work surrounding this, so perhaps it is extremely strict and this is a silly question- I just assumed they would like to present a good, encouraging front to reassure investors or something. Most of the financial reviews I’ve read have been pretty positive even if they have not turned massive profits yet.

I also looked up audit opinions as I’ve not heard of that before and I’m a bit lost on the types. Is the audit opinion attached together with the financial report? I don’t remember coming cross it in anything I’ve read so far.


(Rob Sexton) #5

Inevitably, and despite the regulation and the auditors best efforts, there will be a bit of a positive spin - although much less than you would have seen a few years ago. However the key thing is they now have to mention any negatives, in theory with equal prominence to the positives. So it may require a bit of reading between the line, but the key stuff should be there.

For the audit opinion, it should be with the year-end financials. For the kind of companies you can invest in on our platform, most will produce large annual reports - in these the audit opinion is normally the last thing before the income statement or balance sheet.