UsingFinancial

StatementsforRule#1Inves8ng

AndrewBargerstock/AndrewHaritonMBA,CPA,PhD MTax,CPA

Financial Statements Tell a Story

�  Financial statements reveal the reality of what is happening.

� Rule #1 uncovers the picture about how companies are doing.

…SO THAT WE CAN PREDICT WHAT THEY MAY DO IN THE FUTURE.

Basic Financial Statements

� Balance Sheet

� Income Statement

� Cash Flow Statement

Balance Sheet Formula

A = L + E

Assets = Liabilities + Owner’s

Equity

Assets Things you own � Cash � Receivables � Inventory � Equipment � Buildings � Intangibles

Liabilities Things you owe � Payables to: -- vendors -- government � Loans from: -- banks -- bond holders

Owner’s Equity � Contributed Capital ◦ monies from IPO

� Retained Earnings ◦ profits not distributed as dividends since beginning of company existence ◦ ties into Income Statement

Home Depot 2013 Balance Sheet Assets:

Current assets $15.4 Long-term assets $25.7

Total assets $41.1

Liabilities:

Current Liabilities $11.5 LT Liabilities $11.8

Total Liabilities $23.3

Owners Equity:Common Equity $0.5 Retained earnings $28.0 Treasury Stock ($10.7)

Total Owners Equity $17.8

Total Liab.+ Owners Equity $41.1

Asset Values are Historic � Balance Sheet shows the historical cost of assets…. not current market values

� Many companies possess “off balance sheet assets” like implicit goodwill (not recorded), patent values

� Cash basis: revenue when cash flows in and expense when cash flows out.

� Accrual basis (GAAP required): revenue earned when there is an exchange of value and expenses recognized when incurred. No collection or payment needed.

Accrual vs. Cash acctg

Home Depot Income Statement

2013 $ %

Sales $74.7 100%

Cost of Goods ($48.8) 65%

Gross Profit $25.9 35%

Operating Exp $18.1 24%

Oper. Income $7.8 10%

Income Taxes ($2.7) 4%

Net Income $5.1 7%

Home Depot- Cash Flow 2013 ($billions rounded)

Cash Operations $6.98

Cash - Investing ($1.43)

Cash - Financing ($5.00)

Change in Cash $0.50

HD Details of Cash – Investing (in $billions rounded)

Buy: Acquisitions ($0.17)

Buy: Property, Equipment ($1.31)

Sale: Property $.05

Cash from Investing ($1.43)

Home Depot- Cash Flow 2013 ($billions rounded)

Cash Operations $6.98

Cash - Investing ($1.43)

Cash - Financing ($5.00)

Change in Cash $0.50

Stock Buyback Effects Buybacks produce reduction of cash and reduction of stockholder’s equity by reducing the number of common shares outstanding. � EPS and FCF increase � ROA and ROE increase � Book Value decreases

Big 4 Growth Rates � Book Value/sh. + Dividends/sh.

� Earnings/sh.

� Operating Cash Flow / sh.

� Sales revenue / sh.

#1: Book Value + Dividends

Book Value/sh. = Owner’s Equity divided by # common shares (essentially liquidation value) Dividends/sh. = Total dividends paid per year divided by number of shares

#2: Earnings per share

Net Income

# common shares

… expressed in dollars per share

#3: Cash Flow / share

Cash flow operations # common shares

… expressed in dollars/share

#4: Revenue per share

Sales Revenue / share =

Sales Revenue # common shares … expressed in dollars/share

Refresh: Big 4 Growth Rates

� Book Value/sh. + Dividends/sh. � Earnings per share � Operating Cash Flow per share � Sales per share

… all four cylinders of profit growth running smoothly

Management � Return of Equity (ROE) � Return on Invested Capital (ROIC)

� Debt repay in years

Basic Concept: ROI

Return on Investment = Earnings / Cost of Investment Example:

$50,000 / $1,000,000 = 5%

Return on Equity: Annual return on initial invested

plus profits not distributed

Net Income Common Stock Equity …. Expressed as a % (10% or more) and often >20%

Return on Invested Capital Annual Return on Debt and Equity

Net Income____________ LT Debt + Total Stockholder Equity …. Expressed as a % (10% or more) usually equal to Return on Assets

Time to repay debt What is the weight of debt?

Total LT Debt Net Income

…. Expressed in years (nearest tenth); seeking 3 years or less

Valuations � Margin Of Safety ◦  EPS from Income Statement

� Payback Time ◦  Free Cash Flow from Cash Flow

Statement

� Cap Rate ◦  Owners Cash Flow… from Cash Flow

Statement

Conclusion: • Knowing a little bit about how financial statements work will give you important insights into how a company is really performing. • With the Rule #1 website, you gain a valuable tool to save time and sharpen your search for wonderful companies.

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