Weekly Lesson Wednesday📝 

Spotting Risks from the balance sheet 📑

^_Lesson
Red Flags 🚩

Taking a dive into a companies balance sheet is one of the most obvious ways to evaluate a companies performance. It’s the raw details. However, it can be a mind fuck of numbers sprayed across a page. I’ve been there personally. I’m not a fucking accountant……I have a personality!

So to help you boys out. I’m going to lay out some of the possible red flags you can spot from a balance sheet, that will help you stay away from the shit shocks out there.

1️⃣ GOODWILL/TOTAL ASSETS > 25%

In simple terms goodwill is the belief that the company will do well in the future. But a Goodwill that’s too high may signal excessive expectations, which the company may not live up to. leading to a future devaluation of the firm's worth. So you want it to be a healthy number greater than 25%, but really shouldn’t be higher than 40-50%.

2️⃣ INVENTORIES → going up or down ?

Inventories going up might warn of one or many of the following: weaker demand, obsolete products, excessive supply. So be aware when you see this figure flying !

3️⃣ CURRENT RATIO (short term assets vs short term debt) < 1

If Short term debts are higher than short term assets, the company might have both a solidity and liquidity issue. It essentially whether the company has the assets they can turn into cash to pay off their debts.

4️⃣ NUMBER OF SHARES → going up ⬆ or down ⬇️ 

Increase in shares outstanding (or shares going up) will dilute current shareholders and decrease earnings per share. which could negatively impact the company's stock price and reduce investor confidence. This dilution can make the company less attractive to current and potential investors, potentially affecting its ability to raise capital in the future.

5️⃣ REVENUE → going down 📉

Obviously this is a bad sign ! Temporary problems are normal, especially for businesses that experience ups and downs. So can except the quarterly mishaps. However, we want to avoid permanent issues and businesses on the verge of decline. So if you see this trend over the long term. Stay clear !

6️⃣ REVENUE STREAMS → one or many ? ONE!

We would like to avoid one-off type sales (we love recurring revenue streams) and avoid business models that rely too heavily on just one product, one market, or one service. The more ways to make money the better ! Obviously

7️⃣ R&D EXPENSES ( Research and development) / Net Revenues

Is the company innovating or just sticking to the status quo? What new developments has the company introduced from those R&D expenses recently? You have to keep with the times. Always evolve and not stay static.

8️⃣ OWNERSHIP → held by insiders ? < 15%

We have preached this time and time again ! Are the owners invested in their company. An owner operated company is more likely to do well in the future because top managers interest are aligned to the ones of major shareholders

9️⃣ Return on Invested Capital (ROIC) vs. Weighted Average Cost of Capital (WACC): Excess capital return (especially valid for mature businesses)

When a company generates returns that exceed its cost of capital, it ensures its survival because it can both create value and maintain financial independence. This means the company is efficiently using its resources to generate profits, which not only helps it grow but also reduces its reliance on external funding.

🔟 GROSS MARGIN → going down

It's important to grasp how much control a company has over its pricing, how sensitive customers are to price changes, how well it manages costs from suppliers, and the potential for expanding its operations.

We should aim to avoid a decrease in gross margins, which rarely occurs under normal circumstances!

Summary ⭐

The ability to read off the financials of a company is invaluable. This short snip-it is just a crash course for you to spot obvious red flags on a companies fundamentals. This can allow you to rely on yourself to do your own dd, instead of looking up analysts ratings.

Thanks a lot boys, like always not financial advise. See you tomorrow.