When I first started investing, I was taken aback by the amount of information that I had to sieve through from financial statements and annual reports. The investing jargon and barrage of numbers made me think that investing in stocks was extremely difficult.
Thankfully, I managed to find a few investment books that taught me ways to simplify the process, and I learnt what the important aspects of a company’s report to focus on were.
This made investing and sieving through company data so much simpler and enjoyable. With this in mind, I have decided to write a three-part series on gathering information from the three financial statements – the balance sheet, income statement and cash flow statement.
This is the second part of the series where I will discuss three vital facts we can pick up from the income statement. The first part can be found here.
The Income Statement
The income statement provides information on the company’s revenues, various costs involved and the overall profit or loss. This financial statement is usually split into operating and non-operating sections. The operating section will underline revenues and cost in the key operating aspects of the company while the non-operating section will show the cost and revenue from other activities of the company.
Revenue and Earnings Per Share
Probably the two most important numbers that all investors focus on are the revenue and earnings per share. The earnings are not called the “bottom line” for nothing. It is what investors look at most often and in many cases is what we use to value a company.
However, it is important that we do not look at these numbers in isolation. Revenue and earnings can be distorted by one-off gains. Therefore, investors should compare these numbers with past years’ to get a picture of how far the company has come and whether it has been able to sustain or even grow its earnings and revenues.
One of the key aspects of a business that Warren Buffett looks out for is a high operating profit margin. The company that can achieve this is more likely to have an economic moat that can give it pricing power over its competitors and is less likely to face losses even in harsh business conditions.
This is because it has the leeway to drop prices in poor business environments and still maintain a healthy profit.
Companies that have a history of expanding their profit margins are even more appealing as they have shown the capacity to increase their pricing, adapt to the times and grow their businesses.
Keeping Costs Low
Income statements provide information on the breakdown of the cost of operation. As investors, we should look out for companies that can keep its cost low despite expanding its business.
A good way to gauge this is by looking at cost as a percentage of revenue. If the company’s overall cost is growing faster than revenue, it may be a sign that the company may not be managing its cost effectively.
The Foolish Bottom Line
An income statement gives us a good understanding of a company’s profitability, and by comparing it with previous reporting periods, we can get a glimpse of how the company has grown.
To the new investor, the income statement might seem like a barrage of numbers and financial jargon, but by breaking it down into bite-size portions, we can sieve out the useful information that can help us make better investment decisions.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.