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How to determine the financial health of a company?

This is an extension of chapter 27, how to value a company. To really understand how healthy a company is, we have to go deep into financial statements. This is the true fundamental analysis every investor should do if they want to pick their own stocks. But it must be said that even full financial reports won’t tell you the whole picture. There are many ways to book results or debts making it hard for investors to really figure out where all the money is flowing. There is a reason why accountants exist. 

Things to look for to determine the financial health of a company:

  • Profitability
    • Net profit margin
    • Return on assets
    • Return on equity
  • Operating efficiency
    • Operating margin
    • Operating ratio
  • Liquidity
    • Current ratio
    • Quick ratio
  • Solvency
    • Total debt to total assets ratio
    • Debt to equity ratio
  • Free cash flow

Different ratios to determine if the current price reflects the intrinsic value:

  • Price to earnings ratio (PE ratio) and price/earning to growth ratio
  • Price to book ratio
  • Debt to equity ratio
  • Graham’s value investing formula
  • Margin of safety
  • Trend performance

Valuing a company is an art. If you give one hundred different experts the exact same numbers, you’ll get one hundred different evaluations. That's why there are so many mutual funds, hedge funds and many other investing institutions. They all think they know best. There is no best way to value stocks. This totally depends on how much risk vs rewards you want to take. 

Another thing that might make it very hard to value a company is future growth. To understand the future growth, you need to know everything about the products or services the company is making and compare this with the current market. So you not only need to know what the business is doing, you also need to understand the market and the competition. It makes no sense to buy stocks from Apple if you have no clue what an Iphone or Ipad is. You need to understand the products and the people that buy the products. Invest in what you know. 

Every company is different, so are it’s investors. You can value companies based on aggressiveness, future growth and many other metrics. It’s impossible to go in-depth in each possible option to evaluate a company. But most of the foundation always lies within the financials. Let’s have a look at the different things we can get out of financial statements. 

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Important note before we begin:

All ratio's mentioned in the following chapters are simply ratio's. That does not mean these are leading or that  you can't use other ratio's (there are many more) to determine the health of a company. Just like with day trading where various indicators can be used in different ways, ratio's to determine the health of a company can also be used in different ways. My trading tools are build so you can add your own personal scores to each ratio's. It's important that you can determine your own scores rather then me telling you what you should do. 

My goal is to help you make profitable investment decisions. Because valuing companies can be hard I created various tools that will help you make more confident decisions. I already did the hard work by evaluating every company around the globe with the above mentioned metrics and ratios, including full financial statements and balance sheets. You can determine for yourself if this is imporant for you or not by giving a personal score. For example, check out Tesla.

In my tool you can find the following data from tens of thousands of companies worldwide going back at least 20 years (if available):

1 Company's Financial Health

  • 1.1. Profitability
  • 1.2. Operating Efficiency
  • 1.3. Liquidity
  • 1.4. Solvency

2. Market Valuation

  • 2.1. Price to Earnings
  • 2.2. Price to Book

3. Summary

  • 3.1. Key Performance Indicators and trends

Extra: full reports

  • Latest income statement (annual)
  • Balance Sheet (yearly)
  • Balance Sheet (quarterly)
  • Cash Flow (yearly)
  • Cash Flow (quarterly)
  • Income Statement (yearly)
  • Income Statement (quarterly)

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