Friday, December 25, 2015

The Importance of the Cash Flow Statement

The Importance of the Cash Flow Statement

Cash is not everything, but it makes everything different. 

Companies fold not because they are unprofitable, but because they are not able to settle their financial obligations that are due for settlement. 

Most people look at the cash position in the balance sheet, compare it to that of a year ago, and then decide whether the company has improved or not. They wouldn’t be bothered to look at the Cash Flow Statement (CFS). 

Actually the CFS must be studied in detail to gain an insight of what has happened to the cash of the company. Some people like to read it from the bottom to the top, some prefer to read it from the top to the bottom.  It doesn’t matter how you read it as long as you get the facts right.

Cash flow is about cash inflows and cash outflows. It is not about profits. A company may make profits, but its cash may have dwindled. On the contrary, a company’s cash may have improved while the company is showing a loss.

Cash can flow in via the operation of the business, investing activities  financing from banks, right issues, bonds, etc

Cash outflows are operating expenses, interest payment, taxes, company shares buyback, capital expenditure, the purchase of property, etc. 

The CFS will show you all these information. You need to study it carefully before deciding whether a change in the free cash flow is good or bad. 

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Sunday, December 20, 2015

Learn more about earnings

In business, the priority is earnings. You need earnings to settle your operating expenses, pay taxes and expand your business. 

No company can survive without earnings. Earnings go by different names. Profit, income, the bottom line and earnings are all the same.

EPS (earnings per share) is the most often used metric to evaluate a company. Many people just look at EPS and then decide whether the company is good or no good. This is a mistake. 

When you look at EPS, you must also look at revenue and the actual amount earned so as to have an idea about its profit margin. A high profit margin is better than a low one.

Often overlooked is the quality of earnings. Earnings can come in many forms. These are: 

01) Profits from normal trading and services provided by the company

02) Sale of a property or some properties that are outside its business model

03) Sale of treasury shares 

04) Sale of some financial instruments, such as equities or bonds

05 A change in depreciation rates

06) Appreciation of foreign money against the local currency

All the above activities can affect earnings. So, the next time you look at EPS, do not forget to read the income statement in the quarterly or annual report to know how the earnings come about. Bear in mind that some earnings are just one-off affairs and are not repeatable in the foreseeable future.

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Friday, December 18, 2015

Know FA to invest well

There are 3 important statements to carefully look into when you analyse a company. They are: the balance sheet (BS), income statement (IS) and the cash flow statement (CF)

The BS shows on a certain date what the company has and what it owes others.

The IS shows the sources the profits come in.

The CF statement shows how cash flow in and out of the company.

When I study the balance, the first thing I look at are the current assets and the current liabilities. From this I work out the current ratio. If the current ratio is below 1, I take this as a red flag, and I shall not bother to dig deeper into the stock. This is my personal style; it is not a standard criteria for you to follow.

Cash is a very important item.The more the better. If a company has plenty of cash, it can do many things. It can expand its business, use it to acquire new businesses, purchase its own shares or distribute some of it to its shareholders.

Debt is the opposite. A high debt, especially one with high interest rate, relative to its paid-up capital is a red flag. Bear in mind that debt has to be serviced. This means interest has to be paid. A company that has a not of cash and much borrowings is not in a strong financial position. 

Personally, I prefer small-cap stocks and mid-cap stocks instead of big-cap stocks. Big-cap stocks are suitable for institutions and fund managers. As a small player, you can’t compete with them. Once institution or fund managers have taken notice of a stock, the stock will no longer be cheap. 

There are many other things to consider when you look at the BS. For example, when you look at the accounts receivable or inventory, you need to concern yourself whether these can be easily turned into cash. 

Many things are discussed in my Telegram Super Group. If you wish to learn more to invest intelligently in the stock market, you may join my group. To do this, ensure you have telegram in your phone, are willing to show your true identity via your profile picture, and willing to share with others your knowledge and skill in respect of stocks and shares. 

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Wednesday, December 16, 2015

ROE Can Be Misleading

A high ROE may not be as good as a low ROE

ROE ( Return On Equity) is a common metric used to gauge the competency of the management. ROE is calculated by dividing the net profit by the shareholders’ equity and expressed as a percentage. Most people think that a higher ROE is better than a lower ROE.  Let see whether this is true.

Shareholders’ equity is the total assets minus the total liabilities.

Consider this scenario: Company ABC has a paid-up capital of 1000, net earnings of 100 and zero debt. Thus its ROE is 10%
(100x100/1000)

Company XYZ also has a paid-up capital of 1000 and earnings of 100, but it has debt of 200. So its ROE is 12.5% (100x100/800)

Assuming that both companies are in the same business. Which is the better company? 

Company ABC has a lower ROE than Company XYZ, but obviously it is the better company.

ROE is a useful metric only when you know how to use it intelligently. 

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Monday, December 14, 2015

The Current Ratio What It Means

The Current Ratio What It Means

One of the metrics I like to look at when I assess the financial health of a company is the current ratio. This ratio is calculated by dividing the current assets by the current liabilities.

The current assets consist of cash, receivables, inventories and financial instruments that can be easily turned into cash.

The current liabilities consist of payables, debts, taxes and dividends that are payable within a year.

The purpose of this ratio is to know how capable the company is in paying its obligations when they fall due.

A ratio of below 1 is not a good sign. This does not mean the company will go bankrupt, but it does mean that it may have difficulty settling payments that are due to be paid. 

A current ratio of between 2 to 3 is preferable. If the ratio is above 3, it may mean that the company is not competent in using its assets to generate returns.

When you compare current ratio it must be done among companies of the same business to be of any use. Simply put, a higher ratio than 1 is better than a ratio of below 1.

To invest intelligently, you never look at 1 metric alone. There are many other things and metrics to look at. The most common ones are: the calibre of the management, business modal, price-earnings ratio, return on equity, market capitalisation, enterprise value, dividend yield, price to sales ratio, price to book value, acid ratio, return on capital employed, net tangible asset, margins, free cash flow, etc.

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Thursday, December 10, 2015

Don't Lose Money

What does Warren Buffett mean when he says: Don’t lose money?

For me it means as follows:

01. Don’t speculate or gamble
Gamblers or speculators lose money in the long term although there are occasional gains because of luck. The odds in gambling are always in favour of the House or Banker. That’s why all gamblers, except the professional ones, make money in gambling. Ask yourself. Are you a professional gambler?

02. Don’t listen to insiders
If you think that insiders are keen to make outsiders rich, you are being naive. Insider trading is an offence. Why should an insider take risk of being prosecuted by giving you, an outsider, inside information to make money? Many people are impoverished by what is called an inside tip. Be extra careful especially when the tip is said to come from the horse’s month.

03. Don’t buy what you don’t understand
Many people like to tag along with their friends. They buy I buy. This is not a good idea. Your must know what you are buying. 

04. Don’t play with borrowed money
Play within your comfort zone. Playing with borrowed money will make you edgy. Fear causes irrationality. When you are irrational you are likely to make mistakes that are costly.

05. Avoid rubbish shares.
Shares with high borrowings and little or no earnings and no dividend yields are too risky to get involved. All companies that fold are those with high debits they cannot service. 

06. Insist on value when you buy
Everything has a fair price. To be safe, limit your purchases only to stocks with strong balance sheet, good cash flow, and good growth potential at undervalued prices. Buy dollar notes for 50 sen as advised by Benjamin Graham, the great legendary investor. 

07. Timing is everything
Warren Buffett calls this: The perfect pitch. You will do well to wait for a golden opportunity before you act. Most people do not have the patience to wait. They act in haste and lose money.

08. You can’t win without knowledge and wisdom
“How can the unarmed go into a mortal combat and hope to escape unscathed /James Dine.” The stock market is a battlefield wherein are professionals working full time playing against you.  Are you good enough playing against them? No way, right? Never overestimate your own ability.

The opinion stated above are my own. You may disagree. But if you wish to learn more, you may join me in my Telegram Super Group where you may voice your opinion, share your knowledge and experience, and concur with other members for mutual benefits. What you need to do is to install Telegram into your mobile phone and pm me. My phone number is: 016 9321849. 

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