Read value investing part 1 before reading this.
How to find the value of a stock in its financial report and balance sheet?
Financial reports are published annually as well as quarterly. These are available on the company website if you look for them. You can also find them on the NSE and BSE website. Annual reports are very important for a value investor. Annual reports should be analyzed thoroughly before investing in any company. Annual reports not only give us quantitative aspects of the company but also the qualitative aspects. Qualitative aspects such us what are the immediate challenges of the company, what are the growth prospects of the company, what they are doing to increase their business, How is the management etc.For example, a manufacturing company such as Exide industries are making batteries.If they are setting up a new factory to increase their production which in turn will increase their revenue and profit can be found in their annual report.
On the quantitative side the companies provide three things:
- Profit loss statement
- Balance sheet
- Cashflow report
As a value investor, you must look into each of these reports before investing. If these reports sound interesting then only you should invest or else skip. One of the good thing about annual reports are you will be able to compare it with the previous year reports given by the company. If by comparing you find that every year the revenue and the profit of the company is increasing then it is a good sign that the company is growing and you can invest in it.
Let us now see what are the things that we can find by looking at the balance sheet:
In the balance sheet there are three things mentioned:
The assets can be classified in qualitative terms into:
- Tangible assets-The assets that we can see are tangible assets.Assets such as factories, equipment ,machinery, building etc are tangible assets.
- Intangible assets-The assets that we cannot see in physical form are intangible assets.For example, the assets such as the copyrights, brand value, trademarks, goodwill etc are intangible assets.
The assets are classified in quantitative terms into:
- Current assets-The assets that will only last for 12 months are known as the current assets.
- Noncurrent assets- The assets which will last for more than 12 months are known as noncurrent assets. They are usually long term investments of the company in order to reap benefits.
Similarly, liabilities are of two types:
- Current liabilities-These are the obligations of the company which is to be paid by the company within a period of 12 months.
2.Noncurrent liabilities-Are those obligations which are to be paid by the company after 12 months and more.
A value investor looks for the current assets and the current liabilities. They determine a ratio known as the current ratio.It can be found by dividing the current assets by the current liabilities. The higher the ratio, the better. A value investor looks for the ratio to be 2 or more. This means the company should have twice many assets as compared to the liabilities. Comparing this ratio with previous year ratio and the related company gives us a perspective of the current situation of the company.
You can also calculate one of the important financial ratios known as the net current asset per share. It can be calculated by subtracting the net current liabilities from the net current assets, the result that we get should be divided by a number of outstanding shares. A lower net current asset per share is considered a good sign for a value investor.
Another important ratio that should be found by a value investor is a debt-to-asset ratio. This can simply be found by dividing all the liabilities of the company with the assets. The lower this ratio,the better. The liabilities should not exceed the assets by more than 50% according to Benjamin Graham who is well-known value investor of his time.
Two important financial ratios should be always considered by value investors. The two financial ratios are Book value per share and price to book ratio. Book value per share can be found by obtaining the company’s net worth. Company’s net worth can be found by subtracting the liabilities from the assets of the company.The company’s net worth should be divided by the outstanding number of shares.This will give us the Book value per share of the company.A value investor finds company’s which are trading lower than the book value per share.Price to book ratio can simply be found by dividing the price of the stock divided by the book value per share.This number should be lower.