Fundamental Analysis Made Easy

There has been radical shift in the way most investors make decisions. Today most every investor and trader use technical analysis to make buying and selling decisions in the stock market. Just a few years ago, most investors used fundamental analysis as a big part of the decision making process. The shift to technical analysis has become so profound that traders who understand stock charts sometime don’t even need to know the name of the company before buying or selling it.

I believe that both fundamental analysis and technical analysis should be used in tandem to make the wisest investing decisions.

Fundamental analysis may seem difficult to modern day technical analysis traders. However, it is very simple. The best step is to learn how to analyse an earnings report.



How To Analyse An Earnings Report

All U.S. earnings reports are designed the same way. They are broken down in this way:

Part 1. Financial Information

  1. Financial statements
  2. Management’s analysis of financial condition
  3. Market risk disclosures
  4. Controls and procedures

Part 2. Other Information

  1. Legal proceedings, risk factors
  2. Unregistered equity sales and use of proceeds
  3. Senior securities defaults
  4. Additional information
  5. Exhibits

I know this seems like an overwhelming amount of information to digest.  But it can be broken down into the following 3 steps.

Step 1.  Start with the basic financial numbers

The basic critical numbers are revenue, net income, diluted earnings per share and earnings before interest and taxes (EBIT). Compare these items with the previous quarter and year over year. Ask yourself is the company growing based on increasing numbers? Are the numbers stagnant or decreasing over time?

Step 2. Move on to the cash flow numbers

Look to see where the cash is coming from?  Is the company earning cash from operations or using cash to operate? Make sure the cash flow is positive. Remember, companies often show positive net income but negative cash flow. This is a red flag that all may not be as it seems with the company.

Step 3. Analyse the risks

Once you have ascertained the company is in good financial health, the next step is to ascertain the risks.  Legal proceedings are a critical risk factor. Although many companies have multiple small damage suits, pay particular attention to class action lawsuits. These can do tremendous damage to a company, win or lose, due to the high costs of defense.  The SEC requires companies to list their risk factors under Item 1A in the Other Information section of the earnings report.  Make sure there is nothing fishy here or downright frightening to the future of the company. Many times very negative factors are couched in expertly chosen words designed to lessen the impact of the situation. This means that a careful reading is critical for a complete understanding of the company’s situation.

Remember, the critical thing to look for is improvement from quarter to quarter and year over year. A company is either growing or it is dying.  Steady growth in the financial metrics combined with low risk factors is a recipe for future success.

Disclosure: None.

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