Robot Financial Advisor

Reads the XBLR instance file from the SEC EDGAR website of public companies to perform an initial analysis.

Technical Elements in Financial Analysis

Profitability

This pertains to the ability of the company to earn income and sustain growth in both the short- and long-term business transactions. Usually, this is based on the income statement which presents the company’s results of operations. The income statement reports the sales, cost of sales, expenses, taxes, insurances, and the net profit of the company.

Return on Sales

The Return on Sales (ROS) ratio tells you how efficiently your company runs its operations. Using the information on your income statement, you can measure how much profit your company produced per dollar of sales and how much extra cash you brought in per sale.

You calculate ROS by dividing net income before taxes by sales. For example, suppose your company had a net income of $4,500 and sales of $18,875. (If your business isn’t a corporation but rather is run by a sole proprietor, you don’t have to factor in any business taxes because only corporations pay income taxes.)

The following shows your calculation of ROS:

Net income before taxes ÷ Sales = Return on Sales

$4,500 ÷ $18,875 = 23.8%

As you can see, your company made 23.8 percent on each dollar of sales. To determine whether that amount calls for celebration, you need to find the ROS ratios for similar businesses. Again, check with your local Chamber of Commerce, or order an industry report online from BizMiner.

Return on Assets

The Return on Assets (ROA) ratio tests how well you’re using your company’s assets to generate profits. If your company’s ROA is the same or higher than other similar companies, you’re doing a good job of managing your assets.

To calculate ROA, you divide net income by total assets. You find total assets on your balance sheet. Suppose that your company’s net income was $4,500 and total assets were $40,050.

The following shows your calculation of ROA:

Net income ÷ Total assets = Return on Assets

$4,500 ÷ $40,050 = 11.2%

You calculation shows that your company made 11.2 percent on each dollar of assets it held.

ROA can vary significantly depending on the type of industry in which you operate. For example, if your business requires you to maintain lots of expensive equipment, such as a manufacturing firm, your ROA will be much lower than a service business that doesn’t need as many assets.

Return on Equity

To measure how successful your company was in earning money for the owners or investors, calculate the Return on Equity (ROE) ratio. This ratio often looks better than Return on Assets because ROE doesn’t take debt into consideration.

You calculate ROE by dividing net income by shareholders’ or owners’ equity. (You find equity amounts on your balance sheet.) Suppose your company’s net income was $4,500 and the owners’ equity was $9,500.

Here is the formula:

Net income ÷ Shareholders’ or owners’ equity = Return on Equity

$4,500 ÷ $9,500 = 47.3%

Profitability Ratios

See https://corporatefinanceinstitute.com/resources/knowledge/finance/profitability-ratios/

Margin Ratios

Margin ratios represent the company’s ability to convert sales into profits at various degrees of measurement.

Examples are gross profit margin, operating profit margin, net profit margin, cash flow margin, EBIT, EBITDA, EBITDAR, NOPAT, operating expense ratio, and overhead ratio.

Return Ratios

Return ratios represent the company’s ability to generate returns to its shareholders.

Examples include return on assets, return on equity, cash return on assets, return on debt, return on retained earnings, return on revenue, risk-adjusted return, return on invested capital, and return on capital employed.

Solvency

This refers to the ability of the company to pay its obligation to creditors and other third parties in the long-term. Typically, this is based on the company’s balance sheet which presents the financial condition of a business at a given point of time. The balance sheet contains the list of all the assets, current and non-current, and their totals, all its liabilities, current and non-current, and their totals, as well the items contained in the equity.

How to Judge Solvency on a Balance Sheet

See https://www.dummies.com/business/accounting/how-to-judge-solvency-on-a-balance-sheet/

Current (short-term) assets include cash, marketable securities that can be immediately converted into cash, and assets converted into cash within one operating cycle.

Current (short-term) liabilities include non-interest-bearing liabilities that arise from the operating activities of the business. A typical business keeps many accounts for these liabilities — a separate account for each vendor, for instance.

Current ratio: To size up current assets against total current liabilities, you calculate the current ratio. Using information from the company’s balance sheet, you compute its current ratio as current assets ÷ current liabilities = current ratio.

Liquidity

This relates to the ability of the company to maintain a positive cash flow, while satisfying immediate obligations. Commonly, this is based on the company’s balance sheet which indicates the financial condition of a business at a given point of time and the company’s cash flow which presents the company’s status with regard to the company’s cash transaction in their operating, financing, and investing activities.

Stability

This pertains to the ability of the company to remain in business in the long run, without having to sustain significant losses in the conduct of its business. This can be measured through their balance sheet specifically in their investment and turnover such as receivable turnover, inventory turnover, and sales turnover.

Fundamental Elements of Financial Analysis

Management Team and Board of Directors

As an investor in a company’s common stock, or the shares issued to the public representing standard ownership in the company, you’re at the mercy of the management team to make the correct decisions with your money. You’re counting on the board of directors to keep a watchful eye on the management team. If you can’t trust the management team and board of directors, you shouldn’t trust them with your investment.

Dividend Payment Track Record

Day traders used to scoff at investors who paid attention to dividends. During stock market booms, these small cash payments some companies pay to their shareholders seem almost insignificant.

But fundamental analysts know better. For one thing, dividend payments account for a big portion, roughly 30 percent, of the returns generated by stocks over time. Miss out on those payments, and you’re leaving quite a bit of cash on the table. Also, steady dividends can make sure you’re earning something on your money even if a stock is flat. Dividend payments can also be helpful in helping you decide how much a stock is worth.

Company Promises

It is up to you to verify claims made by a CEO. If a company’s CEO says a new product is selling like crazy, take the time to look at its revenue growth and also the accounts receivable turnover in days to ensure customers are buying and actually paying for the goods. If a company claims to have posted record profits, it’s up to you to not only verify the claim, but also make sure it wasn’t the result of accounting puffery.

Industry Changes

When a company expands rapidly, it becomes more difficult to grow further. These growing pains and maturity present great challenges to both management teams and fundamental analysts. Companies often struggle with the transition from a fast-growth company to a slower growth one, and sometimes need to change their entire strategies. Fundamental analysts, too, much change the way they evaluate a company and measure its valuation.

Fundamental analysis is powerful, but there is a great deal of emphasis placed on financial statements. The big weakness of financial statements is that they’re historical documents telling you how a company did, not how it will do.

Trend analysis is one way fundamental analysts look beyond historical numbers to assess the future. But you need to be especially mindful of game-changing technologies or new ways of doing things in business that can render a company’s way of making money, or business model, obsolete.

Saturation

An analogy from electronics class: when building a circuit with a transistor, you avoid saturation of the transistor because the trnsistor would stop working.
The same applies when a company is saturated.

Competition

It’s often tempting to buy stock in a company you think is the best in a business, and assume that your work is done. But companies are constantly changing and evolving. Sometimes a company’s rival might rise up from near death with a killer product and pose a huge threat. Meanwhile, the valuations of so-called leading stocks are often driven up so high that its future returns are often disappointing.

Overly Confident

Companies can sometimes get full of themselves. Figuring that their fat days will never end, some companies build opulent headquarters, send employees on overly lavish business trips or even spend cash on vanity promotions.