Learn to read Balance Sheets

Publicly traded companies are designed to make money. The conventional way of scoring this pursuit is by looking at the company's ability to grow various flavours of earnings.
Operating earnings, pre-tax earnings, net income and earnings per share are all common measures. However, this is not the only way to determine if there is real value in a company's stock.
A company's real earnings are the earnings that make it from the Consolidated Statement of Earnings to the balance sheet as a liquid asset.
Shareholder value ultimately derives from liquid assets, the assets that can easily be converted into cash. A company's value is determined by how much in the way of liquid assets it can amass.
There are 2 ways to think about this.
  • First - The first is to look at terminal value, which assumes for the sake of calculating potential return that at some future point a company will close down its operations and turn everything into cash, giving the money to shareholders.

  • Second - The second is to look at where tangible shareholder value comes from -- returns on invested capital generated by the company's operations. If a company has excess liquid assets that it does not need, it can deploy the assets in two ways to benefit shareholders -- dividends and stock buybacks.
Knowing what is on the balance sheet is crucial to understanding whether or not the company you are investing in is capable of generating real value for shareholders. Most investors who look at annual reports spend far too much time worrying about earnings and far too little time worrying about the balance sheet and its cousin, the Statement of Cash Flows.
It is the balance sheet that can tell you if a company has enough money to continue to fund its own growth or whether it is going to have to take on debt, issue debt, or issue more stock in order to keep on keeping on.

Does a company have too much inventory? Is a company collecting money from its customers in a reasonable amount of time? It is the balance sheet (the listing of all of the assets and liabilities of a company) that can tell you this.

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