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The amount of ratios that can be found from financial statements is overwhelming. My simple question is, how much do you find is enough? Understood there's more to a company than what's in those statments. But where do you say to yourself- this tells me enough about the company. Right now, I try to get a little on liquidity, inventory, profitablity, etc. (margins, ROE, Quick ratio) and compare them with previous years.

Ott
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No. of Recommendations: 3
Ott,

I'm not sure there is a clear answer to this question. It comes down to your ability to digest the numbers and what you want to focus on. Some people need to break everything down turn it upside down and shake it. Some people get totaly overwhelmed by doing this.

I guess the best answer I can give you is when you have answered your questions to your satisfaction. This will probably vary from company to company.

For some companies I'm comfortable with I check that margins are holding or improving, ROE is where I think it should be and that they are generating quality earnings and free cash. Its short and sweet. For others I not only break them down I break down there competitiors.

For instance I own Boeing (BA) its the most complex company I hold. I spend a fair amount of time going through their annual report each year. From Q to Q I dump there numbers in my spreadsheet and look for an anomaly. Many owners or potential buyers break BA down into its componenets and analyze division by division. I don't see the value in this for my own purposes. I check on division performance, I'll back of napkin some stuff but I look at the whole company when I analyze it. That's what works for me. Its my most complex spreadsheet.

The flip side of this is when I decided to look at GE I came to the conclusion that by the time I did an in depth study of the company and understood its many facets my kids would already be in college. So I checked some really basic numbers, caught up on news and news releases and set my price target using a dividend discount method.

does that help?

jack
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No. of Recommendations: 4
Most important for me is return on capital ratios (ROIC, ROE, ROA) and their improvement. Next is capital adequacy (debt ratios, working capital management). Then comes earnings & cashflow both in terms of growth and margins. Occasionally top line growth is interesting if the company is significant enough to move or tell something about an industry.

I also look for unusual items as I go through the statements. The ratios themselves tend to gloss over the finer details. I find it more useful to go through the numbers before reading the story behind the company to see if the picture story paints matches the numbers.

Marv
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No. of Recommendations: 0
Thank you for your replies. It seems awkward, but it sounds like financial analysis is mostly a subjective matter. Subjective in the sense that a certain company performance may be acceptable by one set of eyes and poor by another. Something strictly based on risk tolerance. I just hesitate being subjective, considering my lack of experience. I don't want to learn the hard way.

Thanks again.

Ott
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No. of Recommendations: 5
It seems awkward, but it sounds like financial analysis is mostly a subjective matter.

It generally is.

That said, I'd like to add one point to this. There are certainly some ratios that many investors happen to think are key - and they generally rely on those.

For me, it all starts with understanding the business model. How does the company make money? Where do they add value? What 'game' or 'strategy' are they playing/using? Once I know the answer to these questions, then and only then do I know which ratios I'm most interested in examining/tracking/benchmarking.

Take Costco for example. What's Costco's business model? Well, low cost high volume. What business are they in? Well, general retail sales. What are the biggest factors that will tell me whether or not Costco is executing this strategy effectively?

Well, inventory turns would certainly be one.

Cash conversion cycle would be another one.

And since Costco is in a 'low margin' business (that's their model after all), I'd care a heck of a lot more about comparable same-store sales at Costco than I might be with, say, Tiffany & Co. This is because the key to Costco's success isn't margins, it's volume.

If one of the key drivers for success is volume, I am going to want to pay special attention to those ratios that focus on volume, and how that volume is managed (like the few examples I've named above).

If I were looking at a different business, in a different industry, with a different model, the key drivers to success will be different, and therefore the ratios that I'll be most interested in will be different.

It all starts with understanding the business and the business model. Figure out what the key drivers for success are for the particular company you are examining, and pay special attention to those ratios that tell you something with regard to how well the business is performing with regard to those key drivers.

Sometimes it helps to have a few 'tried and true' standards that you always look at. This will help you compare one investment idea to another, but again, in my view one should let the business model be one's guide as to which other ratios to include when doing one's analysis.

Regards,

Eldrehad

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No. of Recommendations: 1
Ott,

It seems awkward, but it sounds like financial analysis is mostly a subjective matter.

Almost, we can't afford to be completly subjective or we convince our selves to buy anything or to never buy anything at all.

I would suggest you start with a company or industry that you already know. Ask yourself how does this company make money? Once you have an idea how they make money you can zero in on how well they work their business model.

This isn't really subjective. We can't directly compare Wal-Mart to Exxon. We can take a good analytical look at both companies and decide which one is performing better, this is a little more subjective. Deciding which is a better value is a little more subjective.

The actual process of building an analytical model and feeding it numbers needs to be as objective and dispationate as possible but we will have to make some educated decisions about how to measure this company.

does that help?

jack
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No. of Recommendations: 2
Ott,

Ahhhh, the Holy Grail of investing: what numbers and ratios will give me the "correct" valuation of a company. Like a dream that disappears upon awakening, and is always just beyond our grasp of rememberance, so too is the "right" valuation. It's always just out of reach.

So we make do with what we can. The other responses here have been quite good, and I'll add that I like a company to be generating lots of free cash flow, have oodles of cash on hand, and little to no debt. Of course, I mainly mine for stocks in the small cap sector so I want to be a little more stringent with them than would someone who is investing in a large cap.

Quarterly sales, earnings, receivables and inventory growth I want to look at, along with robust profit margins. I want to see a company investing in itself through R&D expenditures, and I want to make sure they don't dilute shareholder value through excessive option grants.

Some of these I look at more closely than others, and when I read a Fool article or a post that looks at something I haven't seen before, I like to try and incorporate it into what I'm doing to see how it fits. If I like it, it stays in the mix. If not, I'll keep it around for special situations.

There's certainly no hard and fast rules that if you look at this, this and this you'll be able to determine X. But the more times you try to evaluate companies the better feel you'll get for what works for you. Then you can pick and choose additional items to add.

Good luck with your investments.

Rich
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No. of Recommendations: 0
My simple question is, how much do you find is enough?

"Enough" is when you feel comfortable with your decision to buy, hold or sell a stock based on the information you possess and have digested. Ratios are just one means to digest that grand pile of numbers.

KennyO
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