Introduction to fundamental analysis
Quantitative analysis I.II
As mentioned in the first part of this section, the quantitative analysis lets us value the company and understand there this is positioned compared to its competition. We already went through the first financial statement we should analyze: the balance sheet. The following article will provide insights on what information to look at in the income statement.
2. THE INCOME STATEMENT
This financial statement measures how a company has performed in a specific period. It showcases the results of the business’ operations: the revenues, the expenses, and the profits. That is, how much you earned, the amount needed to perform your operations, and what is left after that.
Looking at the statement, how do you think your company could increase profits?
It could do so by either a) lowering the costs of its operations or b) increasing sales revenues.
When do you think each of these decisions will take place? What do you believe it happened during the peak of the COVID-19 crisis to those companies affected by it? Most of them chose the first option, while those that profit from the crisis (delivery companies, for example) chose to expand their business operations or rise their prices to increase sales revenues.
OPERATING EXPENSES
Under this section of the income statement, we will find two main categories:
· Selling expenses
· Administrative expenses: Marketing salaries, utility bills, technology, etc.
Note that these costs are crucial to run a business. Hence, in companies where one of these is essential (as R&D in Google) should not be cut as they ensure the company’s survival.
There are 4 main financial costs that cannot be forgotten: taxes, amortization and depreciation, and interest payments.
If you would like to know where the highest performance of the company is, go to their profit subcategories. If you just look at the net income, you will get a distorted view of the company’s performance.
THE GROSS PROFIT
This profit subcategory results from subtracting sales’ costs from revenues. And the percentage of gross profit to revenue is the gross margin. Have you ever seen the real cost of a cup of coffee?
So, what if you see that a company has high gross margins? Then you would assume that it has enough money to spend in other operations necessary to run the business (i.e. R&D, marketing… etc.)
Look for the downward trends in the gross margin. This could be due to several reasons, some of them include a rise in COGS. Why? Remember: Revenues — COGS = Gross Profit. If we rise the COGS and we are not able to pass these additional expenses to the customers, we will have to bear those costs ourselves. But… why would this occur? Perhaps there is more competition in the market, and we cannot increase our prices, which indicates that our profits might fall in coming periods.
THE NET INCOME
It represents the profit — revenues left after all expenses are paid. In this section, keep the profit margins in mind still. These mean that they have an advantage over their competition because they will have ‘a larger cushion to protect themselves during the hard times’ (Hendriks, et al.). Some strategies to be more competitive in those scenarios is to either decrease prices, merge or acquire other companies, or invest in R&D (Hendriks, et al.).
In conclusion, these are the main takeaways when looking at an income statement:
1. Increasing sales shows strong fundamentals.
2. Increasing margins mean high efficiency and profitability.
3. The data gathered from one company should be compared to other industry players.
4. If the company increases profits over time, it means that they are gaining power in the market.
5. By combining qualitative and quantitative analysis, you can make more informed predictions about the future of that company.
Bibliography:
B&R Investment Guide. Hendriks, P., Heeringa, M., Koenraadt, J., et. al (2020). Second Edition August 2020. B&R Beurs.
