How do you breakdown a company's "Balance Sheet" for investing purposes?

Question

I'm a beginning investor, so step by step would be appreciated!

Answer 1

Super generalization so beginning investors can understand WHY to look at financial statements:

The balance sheet gives you a quick snapshot of the company's current "worth". Basically, if the company was liquidated, what would be left over for investors. You compare year to year balance sheets to see if the company's assets are growing more quickly than their debts and to see if they have enough "working capital" or cash to pay their upcoming debts.

A company that has more Total Liabilities than Total Assets has a negative net worth meaning there is nothing there for shareholders. Also, a company that has Current Liabilities greater than Current Assets may have a hard time paying its bills.

You definitely have to look at the balance sheet in conjunction with the income statement and statement of cash flows. Forget stock beta, earnings surprises or other Wall Street conventions.

Think about this - analyzing a business is a lot like analyzing a person. A person with a positive net worth, that has low expenses compared to revenue and that knows how to generate cash is considered "rich and savvy." If you could bet on a person, you would choose that one over the debt-ridden slob with high bills and a low income. Investing in businesses is the same.

Answer 2

Wow, that's a tough question to answer here. Personally, I use the balance sheet more than the income statement when I choose stocks, but I'm a CPA, so it's not exactly "foreign language" for me.

What I'd like to suggest to you is that you read "The Intelligent Investor" by Benjamin Graham. He's Warren Buffett's mentor, to give you some idea of how sharp this guy was. The new edition has real nice chapter notes from Jason Zwieg, a writer from Money magazine. Granted, it's a long, dry book, but Mr. Zwieg breathes a lot of life into the text.

Good luck!

Answer 3

The financial statement that you should focus on the least is the balance sheet. You are better off looking into Income statement and cash flow statement.

The reason is that assets are recorded in the balance sheet at cost so for example you bought an ice cream machine that cost you $100, but you make $500,000 out of it, the ice cream machine would be valued at $1000 in the balance sheet although its easy to argue that it should be worth much more than that. This is specially true when dealing with unique assets such as patents, buildings, etc

Answer 4

There are multiple books on the topic, which is way too complicated to tackle here. But also study the analysis of "Income Statement" and projected earnings. Projected earnings and the current and expected Price/Earnings Ratio. Those are the very basics.

Answer 5

there are different things to look at for different purposes, first learn or understand what is of interest to you.

there are several items and or ratios to 'pick out' of balance sheets....
net assets, debt ratio, earnings per share, fully diluted earnings per share, amount of working capital, liquidity ratio, asset turnover etc.

learn what each one of these means (not enough time here to teach), learn how to find them, learn what pertains to your investment needs and make sure you compare these ratios on a company-to-company basis and against an industry average basis.