How to Analyze Financial Reports of Companies by IFRS?

How to Analyze Financial Reports of Companies by IFRS?

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In this article, we will discuss a step-by-step algorithm for analyzing the reports of international public companies so that later, you will analyze them yourself. During the report period, a normal person is overwhelmed by recommendations and advice. However, to form a correct and independent opinion, you have to work with the primary source.

Where to start from?

Start the analysis from the website of the company: you will find the reports in the section for investors. See an example in the screenshot below:

Apple (AAPL) - searching reports for Investors

Then a section will open, from where you will be able to download all the reports of the company. Here, we see yearly (10-K form) and quarterly (10-Q form) reports. We are more interested in the 10-K. An example below:

Apple (AAPL) - searching reports for Investors

If you are not keen on looking for all those sections on the company’s website, just go to the website of the SEC regulator - and download the documents from there. In the search form, enter the ticker of the company:

10-K form on SEC website

In the search results, choose the 10-K form:

10-K form on SEC website
10-K form on SEC website

In the USA, companies provide their reports by the U.S. GAAP –the United States Generally Accepted Accounting Principles. The International Financial Report Standards (IFRS.org) do not really differ from them. Hence, hereafter, we will use the U.S. GAAP.

Public companies provide their reports for investors, which allows us to analyze the key points of their performance. Now, that we have found the reports, let us have a look at the most crucial moments.

Why is revenue important?

In the index of the form, we can see the structure of the report; part one contains general theoretical propositions about the company’s business. This part might be useful for a deep understanding of the branch of the economy.

10-K - Apple (AAPL) U.S. GAAP.

As an example, let us take Apple: in the first part, its report contains a comparative analysis of an investment of 100 USD.

10-K - comparative analysis of an investment of 100 USD - Apple (AAPL)

We see that five years after the investment, the sum would have turned into 424 USD, which is tangibly more than 325 USD – the result of investing the same sum into the tech sector of the Dow Jones index. However, we are more interested in Item 6. Selected Financial Data.

Financial Data - AAPL

Let us get started from the main thing – the dynamics of the company’s Revenue/Total Net Sales/Sales for five years. A positive signal is the growth of this index (as in the example). Mind the speed of the growth: if the latter slows down, look for the reasons.

Revenue is a characteristic of how fast the company captures the market. If you find an issuer that will demonstrate stable revenue year by year, this will mean the company has found its niche and is focused on keeping it. To see if the speed of growth of the revenue is enough, compare it with the speed of the general market growth. For example, the shoe market grows by 5% annually, while the revenue of a certain shoe-making company – by 10% every year. (…)

How to find the Net income and Dividends?

To find the net income of the company (the difference between the revenue and operational expenses), go one line down:

Net income - AAPL

This data represents the efficacy of managing corporate finance. It is the essence of the company’s existence. The company’s net profit must be growing for five years before the report. As we see, Apple has not returned to the levels of 2018. Next, we will have a look at the company’s dividends:

Dividends - AAPL

Mind that fast-growing companies at the stage of growth reinvest their income in their development and may pay no dividends at all. Dividend payments are important for forming your investment portfolio, not so much for making a profit on the growth of the stock price. When money is “cheap” in the current macroeconomic cycle, losing companies quite frequently carry out IPOs. In such a case, we focus on the speed of decreasing losses.

Now – for the company’s debts.

What is a large debt?

All companies use loaned money for their development. When the interest rates of the Central banks of developed countries are negative, companies loan money actively. To decide whether the company’s debt is large or not, compare it to the company’s capital. Thus we get the Debt/Equity (D/E) multiplier. To calculate the coefficient, we will need the Total Liabilities and Total Shareholders’ Equity.

Debt/Equity (D/E) - AAPL

In the example, Debt/Equity (D/E) is 3.95, which is acceptable for a tech company. The golden mean here is 1.5 – 60% of loaned capital against 40% of the company’s money. For precision, look at the current liabilities.

Debt/Equity (D/E) - AAPL

They are less than two times larger than the company’s capital, which is acceptable. Meanwhile, if the company’s capital is larger than its debts, this means conservative or inefficient money management. Working with the debt market is both economics and art.

Also, we can compare the Total Assets and Total Liabilities of the company:

Total Assets and Total Liabilities - AAPL

The amount of assets is larger than the liabilities, which means the risk of corporate default is low. If otherwise, check the dynamics of the growth of the debt and the assets. Anyway, I will advise beginners against investing in such companies.

How to calculate P/E, P/S and ROE out of a report?

We can easily calculate a classical multiplier P/E - Price/Earnings (capitalization vs net profit). For this, we need the net profit per stock and the market price of the stock. In the case of Apple, the index is 119/3,31 = 35,95.

Multiplier P/E

This means that the time required for this investment to pay off is almost 36 years. However, the problem with this index is that it does not account for future profits. Hence, nowadays investors actively buy stocks with high P/E. Using the report, we can calculate the average of this multiplier for five years. The result may be used for estimating whether the cost of the company is fair.

In the same way, we can calculate the P/S - Price/Sales multiplier (capitalization/revenue). In our example, the index is 7,85 (2154/274,5), which means the market price of the company is about 8 yearly revenues. Then calculate the average of 5 years and estimate if the company is evaluated fairly.

The ROE (Return On Equity) is even simpler to calculate:

ROE = Net Income/Total Shareholders’ Equity*100%.

ROE = 57,411/65,339*100%= 87,87%.

This means that per each invested dollar the owners will get 88 cents of profit. There is no reference value for ROE: it is to be compared with the average of the last five years and the coefficient of competitors. Anyway, ROE over 50% is almost always remarkable.

Which stocks to buy?

Summing up the above, we conclude that:

  1. The revenue must be growing;
  2. The net profit must be growing;
  3. The assets of the company must exceed its liabilities;
  4. P/E and P/S must be lower than the average of the last 5 years;
  5. If ROE is over 50%, put the stocks in a separate portfolio.

If you analyze the above-mentioned information from the primary source, your investments will be of higher quality than those of 90% of your colleagues.




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