Leigh is a famous 28-year old financial blogger from DividendMagic. His investment of choice is dividend investing, and in his blog he freely (and anonymously) shares the stocks he keeps (and sells) and how they perform over the years.
In this article, he teaches us how to read financial statements so we know which information to look out for.
Some basic information:
- This article is only for complete beginners in the stock market.
- Other people may have different ways of reading financial statements. This is not the right and only way – this is simply one “beginner-friendly” way.
- This article is for people who want to do fundamental analysis, not technical analysis.
- Don’t ask which stocks to buy in Malaysia. Like seriously just don’t. That option is up to you.
“Orait Suraya, just print out the latest annual report of the company you’re interested in,” said Leigh cheerily, “and we go through what BASIC info I personally look out for before I decide to buy the company’s stocks.”
Take the AirAsia Group Berhad for instance. Go to their website, find “Investor Relations”, and download the 2017 Annual Report.
How to read financial statements
1. Key highlights page
“Just have a glance at the company statistics,” said Leigh, “AirAsia nicely turned this section into a visually-pretty infographic, but it’s not always like that.”
It’s important to note that some statistics are industry-specific. For example, load factor is super important for the airline industry. The higher it is, the better.
This is why you should invest in industries you’re familiar with, so you intuitively know what metric and information to look out for.
2. 5-year financial highlights
Don’t be intimidated by the numbers you see – here’s the most important figures to look at and why.
- Note the industry-specific statistics on this page. They are important too. For the airline industry, an increase in passengers carried and load factor are considered good.
- “Restated” (see under 2016) might mean there may have been a material inaccuracy before and this data is the correct version.
- Most times, you won’t get a company financial report that shows everything is perfect. As long as most are good i.e. whatever that should increase, increased, then the company has potential.
Case in point: AirAsia recorded a RM908 million negative cash flow in 2016, but it was due to its financing activities.
3. Look for these ‘statements’
Statement of profit and loss. In this particular case, it’s unique because AirAsia was just incorporated in August 2017 and maybe that’s why it registered a net loss of RM6.336 billion? Most other metric records increase in growth and revenue so that much of a loss doesn’t make sense.
Income statements. Look at their revenue, what they spend on, and how they calculate their “net profit” total.
Statement of financial position – check “liquidity ratio” i.e. do they have enough money to pay debtors if all ask at the same time? Calculation: Net current liabilities divided by assets.
In AirAsia’s case, it’s in the negative – not good actually.
What to do after reading the financial statement
If you liked what you read, buy the stocks. DividendMagic has a comprehensive guide.
If you don’t like what you read, don’t buy it. Pick up another financial statement and do the above simple analysis all over again. You’ll get a hang of it over time.
If you’re curious about “when” to buy the stock, here’s Leigh advice:
- If the fundamentals are good and it just so happens that the price is negatively affected due to temporary bad PR or other factors (CEO died or something), get it like NOW. Usually the price will increase again soon (but not always).
- If fundamentals are good and you’re not sure if the price is going up or down, then if you want it, just get it because the price really could go either way.
If you wait too long, you may not act. The slower you act, the less you get hands-on learning, the actual process that makes you a better investor. Remember to always stay invested.
Other stocks-related questions
Leigh usual process of picking stocks? He buys stocks of companies that offer products/services that its customers generally cannot live without and use on a daily basis.
If you look at his portfolio, he has a combination of company stocks, from banking to food to property.
How many different types of stocks should one have? Maybe stocks from around five to six companies, Leigh says. Diversify a bit. No max, but maybe cap at around 20 because the more you have, the harder it is to keep track of and update your portfolio.
What’s your routine with stocks like, Leigh was asked.
“I log in my trading app occasionally to review prices, maybe once a week. And then really delving into companies if a particular share is doing extraordinarily well or badly. I also read The Edge to keep up with recent updates.”
If you’re a Muslim, go with the process of elimination. First, eliminate all non-Syariah companies. Then look through the remaining companies and see if you’re familiar with their industry enough. If yes, take a stab at reading their financial statements. If it looks good, consider buying their stocks.
Why choose stocks as investments though?
There are mutual funds and unit trusts, right? They are comprised of individual stocks, usually across different industries for diversification.
BUT mutual funds and unit trust charge fees. Some pretty low at 0.35% (ASB), some pretty high at 3% or more.
SO.. by picking your own stocks, you’re avoiding those fees. It can add up to quite a lot. Read up DividendMagic’s calculations in his “That 1% Fee Impact – Mutual Funds vs Investing” on your own article.
(NOTE: Stocks are not fee-free either. There are charges when buying/selling them).
But fund managers are smart people – and you’re paying them a fee for their ability to pick good stocks.
However, actually fund managers don’t necessarily make the best stock picks, despite all the jargon they spew out.
This article first appeared in ringgitohringgit.com
Suraya is a corporate writer-for-hire and the blogger behind personal finance website Ringgit Oh Ringgit. She is more of a minimalist, less of a consumerist, a konon DIY enthusiast, a let’s-support-small-businesses-over-big-corporations kinda girl. Prior to her current role, she worked in various capacities within the non-profit industry.