How to read financial result like a pro17/September/2015

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Step 4: Discover the one figure that indicates the company’s performance

Step 1: How to decipher previous reporting results

Step 2: What can a company’s revenue tell you

Step 3: What a company’s profit margin will tell you

Step 5: Learn to read the commentary that reveals the company’s sentiment

How to read financial results like a stock market veteran

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Step 9: The autopilot money maker

Step 6: How to determine earnings consistency

Step 7: The two liabilities you need to watch out for

Step 8: The one figure you need to define your earnings potential

Step 10: How to decode company prospects

10 steps checklist to read financial results like a pro –cont.

Step 1: How to decipher previous reporting results

Previous reporting results

• Has the company met their previous objectives / targets?

• You’ll find this information on the trading statement summary / Annual reports, or the Chairman`s letter to shareholders

• This sets the scene for the results and also builds the credibility of management when meeting previous expectations.

What is the take-away / action point? IE If the companies previous guidance was met then you can be confident about the management `s ability to meet expectations, previous strategies worked, gives credence to the current results. Opposite is true.

Step 2: What can a company’s revenue tell you

Is revenue beating inflation ?

• Revenue / sales are synonymous

• This basically tells you if the company is growing or shrinking

• Strip out any distortions such as asset disposal or acquisitions

• It gives you a sense of operational efficiencies

• Where you’ll find this information: trading statement, or the annual report presentation

If the revenue beats inflation, it has a pricing power, ability to pass inflation to customers therefore volumes would be up, market share increasing. if the revenue doesn’t beat inflation, sales have dropped, price sensitivities, shrinking market share.

Step 3: What a company’s profit margin will tell you

Profit margins?

•Profit margin: The measure of profitability, it’s the percentage of selling price that turned into profit.•It’s a good indicator of a company`s pricing strategies and how well it controls costs•Low margins indicates a decline in sales / increasing cost pressures, while Increasing margins indicate increasing sales volumes, cost compression, robust operating efficienciesProfit margins also indicates a company`s pricing power (passing inflation) economies of scale benefit, links to life stage cycle etc. If all things are moving in the right direction then you’re looking at a sound operation.•Differences in competitive strategy and product mix cause the profit margin to vary among different companies•Key point: invest in a growth company, that has the ability to increase its profit margins because the share price growth usually follow earnings growth.

Step 4: Discover the one figure that indicates the company’s performance

Headline earnings are a measurement of a company's earnings based solely on operational and capital investment activities. It specifically excludes any income that may relate to staff reductions, sales of assets, or accounting write-downs.

Look out for:- A rising HEPS is better than a falling one. - A share issue to fund growth will usually have a negative impact on HEPS which is not always a negative.- Essentially HEPS movements should be correlated to profits

Headline earnings per share (HEPS)

Step 5: Learn to read the commentary that reveals the company’s sentiment

• Read management commentary and to assess how they feel about the results.

• Be always aware that the commentary will likely have biases that show management did a great job.

• Key take away here is to see if management explicitly highlights key risks to the profitability of the business, “management should not hide negatives factors”

• Good and honest management will write about the negatives as well as the positives in their commentary.

• Use your own judgement to determine is the commentary is balanced, realistic and impartial.

• This commentary should help you see if management is hiding anything which flags some risk to earnings.

Management commentary

Step 6: How to determine earnings consistency

Consistency is the name of the game

•One-off events can seriously distort results•You should try to identify as many as possible •Do your own calculations to get a better sense of consistency•Consider unusual transactions, that management comment on, as they might be unrepeatable business•Sustainable earnings growth means consistent earnings growth•This will give you a true reflection of the company`s ability to grow sustainable earnings.

Step 7: The liabilities you need to watch out for

•Capex considerations: If the company’s spending a fair amount of money on expansion - Where is this cash is coming from; Cash reserves, Debt, or otherwise?•Debt will imply increasing interest cost•Higher finance charges / interest cost imply that lenders such as banks view the company as HIGH RISK•Should you be investing in a high risk company?

What is their interest cover ratio?•The interest coverage ratio is used to determine how easily a company can pay interest expenses on outstanding debt. The ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) by the company's interest expenses for the same period.

You’re not covering two specific ‘liabilities’ – What are they and how do you use them?

Example: EBIT Interest expense

XYZ Co. LTDNet income R420 000Interest expense (R390 000)

Company XYZ can cover interest payment 1.8 times per period, which is fairly safe.

Step 8: The one figure you need to define your earnings potential

ROE (Return on Equity): Indicates how well a company's

management is deploying the shareholders' capital.

•ROE is more than a measure of profit, it's a measure of efficiency

•A rising ROE suggests that a company is increasing its ability to generate profit without needing as much capital

•Falling ROE is usually a problem

Formular : ROE = Net incomeShareholders equityR10 000 000R 20 000 000= 50%

This means that Company XYZ generated 50c of profit for every R1 of shareholders' equity last year, giving the stock an ROE of 50%.

Key points:Write downs and share buybacks can artificially boost ROEHigh level of debt can artificially boost ROE (+ debt; -shareholders equity as a % 0f total assets the higher the ROE can be)Compare this ratio with companies in same industries

Step 9: The autopilot money maker

Dividend: A payment made by a corporation to its shareholders, usually as a distribution of profits.

Dividends are one of the main reasons why investors buy shares because they are, by nature, an investment income.

Questions you need to ask:•Is the company paying dividend?•Has it always maintain the dividend payment?•Are the dividend paid from company profits? (sustainability)•Is the company paying a progressive dividend? Is the pay out•increasing/ decreasing over certain period(ex- growth)

Step 10: How to decode company prospects

Outlook

Finally, taking steps 1 - 9 into account, consider if management sound optimistic or pessimistic about the future.

Is their tone is appropriate, and consistent with the results? If the results are a disaster, but management is massively optimistic, then questions have to be asked…

Often management will try strike a balance between how tough the environment is (because any downside is then ‘not’ their fault) and how well the company is positioned to capitalize on opportunities (because shareholders are so lucky to have them as management).

Ignore the clichéd “balance” remarks, and rather focus on specifics - quantifiable and/or event-based.

Example

In the prospects section of a coal mining company, I would ignore all comments on how tough mining is in South Africa and the softness in the coal price (we all know this already), and would rather focus on any specific comments regarding new mines coming in, old mines shutting down, acquisitions in the pipeline and/or any more focused, company-specific commentary.

These directly impact on your feeling for the company’s results over the short-term.

Conclusion

•If you have able to tick all 10 or minimum 7 boxes in this checklist, you are looking at a great company with a great near term upside, you can invest in those shares.

•When you get comfortable doing this, you should be able to do so within ten or so minutes.

Thank youContact details: 011 384 2948/

tradingdesk@vunaniprivateclients.co.za