Fundamental Analysis - Pillar 1 - Financial Analysis

Investofreaks!

Financial Analysis is one of the two Quantitative means to analyze a company. The other is Valuation Analysis. Its Quantitative hence very Objective number driven - numbers mostly dont lie and even if they do as a small retail investor, in most cases, we can build screening methods in our analysis to have checks to see if they are cooking the books of accounts. Also we have the market regulator SEBI who is also keeping an eye.

To know the 4 pillars to Fundamental Analysis click here

Financial Analysis constitutes the analysis of 3 Financial Statements:

1. Profit & Loss Statement (Income Statement)
2. Balance Sheet
3. Cash Flow Statement

If I am given 100 minutes to analyse all 3 statements and give a analysis report on the company, then I would spend 80% of the time on Balance Sheet and Cash Flow Statement. The reason I want to spend time this way is because "Cash is King" and these two statements tell me exactly this!

Profit & Loss Statement (P&L) (Income Statement) - Here we get answers to the following questions (not an exhaustive list)

• Is the company able to increase the sales of it products/services at a reasonable rate a.k.a Are the sales growing?
• While selling more are they able to maintain profitability if not increase?
• Do the products of the company have a seasonal demand within a 12 month time frame?
• Is the company operating in a cyclical business? Please google what a cyclical business means! 
• Is the company paying corporate taxes per the rules of the government for the industry it operates in?
• Is the company paying a share of its profits to shareholders on a consistent basis? 

Non Finance folks can understand it this way to keep it simple - no rocket science!

The P&L statement tells us about the "financial performance" of the company, while the Balance sheet will tell you about the "financial position" of the company at a point in time and the Cash Flow Statement will tell you if the company is a "cash cow" (google this terms again, very important)

I will write another detailed post on "How to Analyze the P&L Statement" and which free tools on the internet you can use to keep it simple yet effective.

Adieu!

Four Pillars of Fundamental Analysis

Howdy!

Lets get into the core of fundamental analysis now:

Four pillars of analysis in bottom up fundamental analysis of a stock which I follow:

• Quantitative Analysis (Objective) - i) Financial Analysis ii) Valuation Analysis
• Qualitative Analysis (Subjective) - iii) Industry Analysis iv) Management Analysis

As an investor you want to invest in a handful of stocks to create wealth and to do that you need to able to filter or scan them through a series of filters. The above Objective and Subjective analysis does just that for you. Dont be surprised if you arent able to narrow down on even a single stock after taking the company through these filters! You just need to find one or two new companies every couple years to invest.

My belief is that the Financial Statement of a company in most cases reflects a lot about the company in itself. The reason I pick Financial Analysis as my first filter criteria to screen a stock is due to these reasons:-

• A company's economic moat will reflect in its Financial Statements
• If a company has top quality management, that too will reflect in the Financial Statements
• In most cases the industry in which the company operates can be guessed looking at the Financial Statements!

All the four pillars are essential; I prefer to start with Financial, if you prefer to start with management Analysis you wont hurt me; neither will hurt you. 

As an investor you need to stick to what best work for you. There is no one size fits all! 

Untill next time, Chao!