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Financial Statement Analysis: Learn The Best Tricks And Tips!
1. LEARN HOW TO READ
FINANCIALS AND
CALCULATE
IMPORTANT RATIOS!
Financial Statement
Analysis
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2. Financial Statements Overview
Financial statements convey the results and financial
position of a business
We use them to evaluate sales, profitability, cash
flow, and other metrics
In the U.S. financial statements are prepared on a
quarterly and annual basis
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3. Financial Statements Overview
Balance Sheet
Income Statement
Statement of Cash Flows
Statement of Stockholder’s Equity
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4. Balance Sheet
The Balance Sheet presents a Company’s assets,
liabilities, and shareholder’s equity at a point in time
Assets represent future economic benefits
i.e. office building, patents, or even inventory
Liabilities represent future economic sacrifices
i.e. bank loans, accounts payable to suppliers
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5. Balance Sheet
Equity represents capital contributions to the
business + cumulative retained profits (earnings)
Under the accounting equation:
Assets = Liabilities + Equity
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6. Balance Sheet
Current assets/current liabilities
Assets/liabilities that will be consumed (or paid off/settled)
within the next year
i.e. accounts receivable, inventory, or accounts payable
Non-current assets/non-current liabilities
Assets/liabilities that will not be consumed (or paid
off/settled) within the next year
i.e. production equipment, long-term bank obligation
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7. Income Statement
The Income Statement summarizes the profit
generating activities of a business
Most companies report a multiple-step income
statement
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8. Income Statement
JC. Co. Income Statement For The Year Ended 12/31/16
Revenue $100,000
Cost of goods sold ($50,000)
Gross Profit $50,000
Operating expenses:
Selling expenses ($10,000)
General and administrative ($10,000)
Research & development ($5,000)
Operating Income $25,000
Other income (expense)
Interest income $500
Interest expense ($500)
Income before taxes $25,000
Income tax expense ($10,000)
Net income $15,000
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9. Statement of Cash Flows
The Statement of Cash Flows shows how a
company’s cash balance changed over a period
The statement classifies cash transactions into 3
categories:
Operating Activities
Investing Activities
Financing Activities
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10. Operating Activities
Operating activities represent cash inflows and
outflows related to a Company’s main business
activities
Inflows include: cash received from customers for
the sale of goods/services, interest income, and
dividends from investments
Outflows include: inventory, salaries/wages, other
operating expenses, interest on debt, and income
taxes
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11. Investing Activities
Investing activities include cash inflows/outflows
related to the purchase and sale of non-current
assets
Examples:
Purchase/sale of long-lived assets used in the business
Purchase/sale investments in stocks and bonds
Acquisition or disposition of businesses
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12. Financing Activities
Financing activities relate to the external
financing of the Company (debt + equity)
Inflows: (1) shares issued to owners (2) borrowing
money
Outflows: (1) dividends, (2) acquisition of shares,
(3) repayment of debt principal
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13. Earnings-Per-Share (EPS)
Shares are units of ownership in a business that
provide for an equal distribution of profit or
dividends
All public companies have shares that are traded on
stock exchanges
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14. Earnings-Per-Share (EPS)
Basic shares outstanding = the number of shares
outstanding
Sometimes companies issue stock options or other
equity awards to executives as compensation. This
represents “dilution” to current shareholders
Diluted shares outstanding = the number of
shares outstanding + any potential claims on
common shares
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15. Earnings-Per-Share (EPS)
Earnings-Per-Share (EPS) = Net Income /
Shares Outstanding
Represents how much profit the Company generates per share
outstanding
Basic EPS = Net Income / Basic Shares
Outstanding
Diluted EPS = Net Income / Diluted Shares
Outstanding
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16. Profitability Analysis
Gross Margin = Gross Profit / Revenue
Operating Margin = Operating Profit / Revenue
Net Margin (Profit Margin) = Net Income /
Revenue
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17. Profitability Analysis
Analysts typically compare ratio metrics relative to:
(1) prior year results or
(2) a peer company (i.e. a competitor)
A basis point represents 1/100th of a percent
.01% = 1 basis point
1% = 100 basis points
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18. Activity/Turnover Analysis
Turnover ratios are important because they gauge
a company’s ability to convert assets into cash
Asset Turnover = Sales / Average Total Assets
Asset Turnover shows how efficiently a business
utilizes its assets to generate revenue!
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19. Activity/Turnover Analysis
Receivables Turnover Ratio = Sales / Average
Accounts Receivable
Receivables Turnover measures the number of
times during the period that the average accounts
receivable balance is collected
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20. Activity/Turnover Analysis
Days Sales Outstanding (DSO) = # of days in
period / Receivables Turnover Ratio
DSO represents the average collection period for a
Company’s accounts receivables
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21. Activity/Turnover Analysis
Inventory Turnover = Cost of Goods Sold /
Average Inventory
Inventory Turnover measures the number of
times the average inventory balance is sold during a
period
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22. Activity/Turnover Analysis
Days Sales of Inventory (DSI) = # of days in the
period / Inventory Turnover Ratio
DSI measures the number of days it takes for a
business to sell its inventory
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23. Activity/Turnover Analysis
Accounts Payable Turnover = Cost of Goods
Sold / Average Accounts Payable
Accounts Payable Turnover measures how many
times the average payable balance is paid during a
period
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24. Activity/Turnover Analysis
Days Payable Outstanding (DPO) = # of days in
the period / Payable Turnover Ratio
DPO measures how long it takes a business to pay
its suppliers
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25. Activity/Turnover Analysis
Days Inventory Outstanding (DSI)
Days Sales Outstanding (DSO)
Days Payable Outstanding (DPO)
Cash Conversion Cycle = DSI + DSO - DPO
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26. Liquidity Ratio Analysis
Liquidity refers to the ease of ability in converting
assets to cash.
Current Ratio = Current Assets / Current
Liabilities
The higher the current ratio, the more capable the Company is
of paying short-term obligations
Acid-Test Ratio (Quick Ratio) = Quick Assets /
Current Liabilities
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27. Leverage Analysis
Leverage analysis is used to assess a company’s
ability to repay its long-term debt
Interest Coverage Ratio = (Net Income + Interest
Expense + Income Taxes) / (Interest Expense)
Interest Coverage measures how easily a business
can pay interest on outstanding debt.
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28. Leverage Analysis
Debt to Equity Ratio = Debt / Equity
Debt to Equity ratio measures how much debt is
used to finance assets relative to equity
All else equal, the higher the ratio, the higher the risk of
bankruptcy
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29. Leverage Analysis
Debt-to-EBITDA ratio = Debt / EBITDA
Very commonly used by credit agencies
EBITDA = earnings before interest, taxes,
depreciation expense, and amortization expense
Different industries use leverage differently!
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30. Valuation Ratios
“Valuation is an art, not science”
In finance/accounting, valuation refers to the
calculation of a security’s value
Valuation ratios are used to assess how “cheap” or
“expensive” a company is
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31. Valuation Ratios
Price-to-Earnings Ratio (P/E Ratio) = Stock
Price / EPS
P/E measures how much you are paying for a
business relative to its earnings (profits)
Forward P/E ratio: Stock Price / Forecasted
Future Earnings
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32. Valuation Ratios
Price-to-Cash Flow Ratio (P/CF) = Market
Capitalization / Cash from Operating Activities
Market capitalization = share price * shares
outstanding
This ratio measures how much you are paying for a
business relative to its cash flow generation
capability
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33. Valuation Ratios
Price/Sales Ratio (P/S): Market Capitalization /
Sales
Measures how much you are paying for a company’s
revenue
Typically used in start ups, high growth technology
companies, or businesses without profits
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34. Valuation Ratios
Book Value (BV) represents the net assets of a
business.
Book Value = Total Assets – Total Liabilities
BV per-share = Book Value / Diluted Share Count
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35. Valuation Ratios
Price-to-Book Value (P/B) = Share Price / Book
Value per-share
P/B measures how much you are paying for the net
assets of a business.
P/B is most appropriate for businesses with high
tangible assets (i.e. a bank or insurance company)
It is less appropriate for companies that have large
intangible assets (i.e. biotech/pharmaceuticals or
technology companies)
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36. Valuation Ratios
Market Capitalization = Shares Outstanding x
Share Price
Enterprise Value is a more comprehensive measure
of a company’s value
Enterprise Value (EV) = Market Capitalization +
Preferred Shares + Debt + Minority Interest - Cash
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37. Valuation Ratios
Enterprise Value-to-EBITDA (EV/EBITDA) =
Enterprise Value / EBITDA
EV/EBITDA measures the multiple a potential
acquirer would pay for a business
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38. How To Read Financial Statements
ALL public companies are required to file
documents with the U.S. Securities and Exchange
Commission (SEC) on a regular basis
A public company’s SEC filings are available to the
public for FREE at:
https://www.sec.gov/
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39. Key SEC Filings
10-K: An annual report filed with the SEC detailing a
company’s financial performance
10-Q: A comprehensive quarterly report
8-K: A broad form utilized to inform shareholders of key
events
DEF-14A: A Company’s annual Proxy statement
Form 4: A filing detailing executives’ buys/sales of
shares
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40. 10-K
Large companies ($700M+) must file their 10-K 60
days after their fiscal year ends
The 10-K is required reading for any serious
investor!
Warren Buffett reportedly reads over 500 pages a
day!
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41. 10-K
A 10-K is a public company’s annual report with the
SEC detailing its business performance
A 10-K IS NOT the same thing as a company’s
Annual Report to Shareholders!
“All else being equal, invest in the company with the fewest color
photographs in the annual report.”—Peter Lynch
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42. 10-K Reading Tips
Don’t read it all in one sitting
Take many breaks!
The best way to read a 10-K is side-by-side with the
prior year filing
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43. 10-K: Business Section
The Business Section describes the ‘who’ and
‘what’ of the company
The business section typically describes the company’s
products/services, its operating segments, competition, goals,
employees, and market dynamics
It may also include recent events, regulation, labor issues, or
potential lawsuits
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44. 10-K: Risk Factors Section
The Risk Factors section describes key risks the
Company faces
i.e. employee strikes, dependence on a customer, increased industry
competition
Risk factors are often drafted by lawyers so the
language can be ‘boilerplate’
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45. 10-K Risk Factors Section
Key risk factors to watch out for:
Changes in competition
Customer concentration (large customers)
New/pending regulation
Any important lawsuits
Commentary about debt levels
Dependence on certain products
Dependence on certain suppliers or manufacturers
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46. 10-K: Unresolved Staff Comments
This section requires companies to explain
comments it received from SEC staff on previously
filed reports that have not been resolved after an
extended period of time
Any comments should be taken as a red flag!
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47. 10-K: Properties
This section discloses information about a company’s
significant properties
i.e. headquarters, manufacturing plants, store base, square
footage, etc.
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48. 10-K: Legal Proceedings
This section describes all of the Company’s
important legal proceedings
The language may be boilerplate, but can identify key
risks to watch out for!
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49. 10-K: Item 5
Market for Registrant’s Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Item 5 essentially summarizes information about the
company’s shares
i.e. share price highs/lows, volume, dividends, and share
repurchases
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50. 10:K Selected Financial Data
The selected financial data section provides
financial information about a company for the past 5
years.
Most companies will disclose important income
statement and balance sheet data, along with other
key performance metrics
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51. 10-K: MD&A (Highlights + Strategy)
Management’s Discussion of Analysis of Financial
Condition and Results of Operations
The MD&A section typically begins with a discussion
of highlights from the most recent year and the
company’s strategy
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52. 10-K: MD&A (Results Discussion)
The MD&A will include certain financial metrics over
the past 3 years
The Company will also discuss income statement
results over the past 3 years on a ‘line-by-line’ basis
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53. 10K: MD&A (Results Discussion)
MD&A commentary varies, but typically includes:
why revenue increased/decreased
why profit increased/decreased
any one-time expenses
discussion on taxes
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54. 10-K: MD&A (Liquidity & Capital Resources)
The next section of the MD&A focuses on ‘liquidity
and capital resources
Here, the company discusses the significant sources
and uses of cash
This will include a discussion of (1) cash from operating
activities, (2) cash from investing activities, and (3) cash from
financing activities
The final section of liquidity and capital resources
discusses the company’s available credit resources
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55. 10-K: MD&A (Contractual Obligations)
Under “Contractual Obligations”, the company will
list a timeline of its obligations
These obligations may include:
Debt, purchase obligations, and leases among others
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56. 10-K: MD&A (Critical Accounting Policies)
At the end of every MD&A section, the company will
discuss its critical accounting policies
These policies typically include:
Revenue recognition
Inventory valuation
Impairment analysis
Taxes
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57. 10-K: Item 7A
Quantitative and Qualitative Disclosures about
Market Risk
The SEC requires the company to discuss market
risks such as:
Interest rates
Foreign currency
Commodity prices
The company may also discuss how it mitigates these
risks
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58. 10-K: Financial Statements
Item 8 is the part of the 10-K that discloses the
company’s financial statements
Item 8 also includes the auditor opinion and
financial footnotes
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59. 10-K: Financial Statements
All public companies must have an auditor
Most select the “Big 4”—EY, PwC, Deloitte, KPMG
In the 10-K, company’s must release their
independent auditor’s opinion
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60. 10-K: Financial Statements
The audit report will contain the auditor’s opinion
about the fairness of the financials presented and
opinion the company’s internal control
Internal control represents the processes put in place
to ensure integrity of accounting and financial
information presented
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61. 10-K: Financial Statements
Most companies receive an “unqualified opinion” on
their audit
It is important to watch out for internal
control weaknesses!
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62. 10-K: Financial Statements
Balance Sheet for the past 2 years
Income Statement for the past 3 years
Statement of stockholder’s equity for the past 3 years
Statement of Cash Flows for the past 3 years
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63. 10-K: Footnotes
The footnotes are presented after the financial
statements and include a variety of details about the
company’s accounts and policies
Footnotes are often the most important part
of the financials to read!
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65. 10-K: Footnotes
Other important footnote disclosures:
Segment Reporting
Geographic information
Remember: reading the footnotes is
incredibly important!
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66. 10-Q: Quarterly Report
Large companies ($700M+) must file their 10-Q 40
days after the end of the quarter
A quarterly report is an abbreviated filing with the
SEC detailing financial results from the quarter
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67. 10-Q: Financial Statements
The financial statements are presented first
Footnotes are presented after the financial
statements
The 10-Q is much more abbreviated than the 10-
K and contains fewer disclosures
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68. 10-Q: MD&A
The 10-Q also contains a “Management’s Discussion
and Analysis” section
The MD&A starts with an overview of recent
financial performance before discussing detailed
performance
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69. 8-K: Current Report
Form 8-K is the “current report” public companies
must file with the SEC to announce major events
shareholders should know about
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70. 8-K: Current Report
A company should issue an 8-K for:
Acquiring another business
Asset sales
Quarterly results
Issuing debt and/or equity
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71. 8-K: Current Report
A company should issue an 8-K for:
Restructuring plans
Change in accountants
Senior officer changes
Director elections/departures
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72. DEF-14A: Proxy Statement
All public companies need to file a proxy statement
(DEF-14A) ahead of the annual shareholder’s
meeting
Key disclosures include: voting procedure,
background about directors and management, and
compensation
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73. DEF-14A Proxy Statement
Notice of Annual Meeting of Shareholders
Details the who, what, where, and when of the meeting
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74. DEF-14A: Proxy Statement
Solicitation of the proxy: details what is being voted
on and the board’s recommendation
Election of Directors
Will include a background of each director
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76. DEF-14A: Beneficial Ownership
All proxy statements include:
a section disclosing significant (5%+) shareholders
Directors’ and Officers’ beneficial ownership
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77. DEF-14A: Director Compensation
As analysts, we want to know how much and how
directors are being compensated
Directors are typically paid through a combination of
retainer (cash) and equity
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78. DEF-14A: Executive Compensation
Executive compensation is the most important part
of the proxy statement!
A company typically discusses:
Compensation philosophy
Role of the Compensation Committee
Elements of compensation
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79. DEF-14A: Executive Compensation
Elements of Executive Compensation:
Base Salary
Cash Bonus
Equity (options, RSUs, performance-based shares, etc.)
Others/perquisites
Summary Compensation Table
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80. Form 4
All directors, officers, and 10%+ shareholders must
file documents (the Form 4) for changes in share
holdings
A Form 4 MUST be filed before the end of the
second business day following a change in ownership
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81. Form 4: Codes
P: Open market or private purchase of shares
S: Open market or private sale of shares
A: grant, award, or other acquisition of shares from
the company
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82. Form 4: Codes
D: Sale or transfer of shares back to the company
F: Payment of exercise price or tax liability using
portion of securities received from the company
M: Exercise or conversion of security received from
the company
G: Gift (i.e. donation) of securities by the insider
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83. Form 4: Insider Buying / Selling
How many insiders are buying/selling?
Were the purchases/sales significant?
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84. Conference Calls (CCs)
Conference Calls are used my almost all public
companies to report quarterly results
CCs are typically scheduled in advance via press
release
Many CCs are also accompanied with presentations
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85. Conference Calls (CCs)
Conference Calls may also be held for:
Acquisitions/mergers/dispositions
Monthly sales calls
Significant corporate events
Many others
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86. Quarterly Results Overview
Public companies in the U.S. report results
on a quarterly basis
Companies typically set reporting dates in advance
Keep an eye out for the 8-K or press release!
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87. Guidance
Some (but not all) companies provide guidance
Companies may provide guidance on:
Revenue
Margins
Profit
Store openings/closings
Capital expenditures
…and much more!
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88. Guidance
Guidance is not required by SEC reporting
standards–it is entirely voluntary
Stocks can trade off guidance so pay
attention!
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89. Key Performance Indicators (KPIs)
As analysts, we must identify a company’s key
performance indicators
KPIs are typically disclosed and discussed in
earnings releases, conference calls, and the MD&A
section of reports
Some industries have very specific KPIs
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90. Want To Learn More?
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Check out my website to learn more!
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