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Introduction to Investments (Paiano)
Part 2: Stocks, also known as Equities
Chapter 5: Fundamental Analysis: Financial Statements and Ratio Analysis

Chapter 5: Fundamental Analysis: Financial Statements and Ratio Analysis

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“If an accountant’s spouse cannot sleep at night, all he or she has to say is, “Dear, tell me about your day at work.”

Learning Objectives

In this chapter, you will

Explore the three quarterly and annual financial statements that every publicly traded company must produce: the balance sheet, the income statement, and the cash flow statement (aka statement of cash flows)
Investigate Regulation FD (Fair Disclosure) and how financial statements and other important data about companies are disseminated
Review some common stock ratios first discussed in chapter 3 and be introduced to new common stock ratios and price ratios
Utilize an electronic spreadsheet to calculate the Internal Rate of Return from a series of cash outflows and inflows
Be introduced to profitability ratios, liquidity ratios, activity ratios, and leverage ratios

By the end of this chapter, you should be able to

Describe the uses of the three quarterly and annual financial statements
Research or calculate various financial ratios for publicly traded companies
Analyze and compare and contrast the various financial ratios for publicly traded companies with their competitors and the stock market as a whole

Ratio Analysis Rounds Out the Investigation of Our Potential Stock Investments

In the previous chapter, we learned some powerful techniques that give us a “yes/no, continue researching/don’t continue researching” kind of answer, even though we know that we should never place much credence in the result. In this chapter, we learn how to compute and analyze many financial ratios using the financial statements that a public company must publish quarterly. Financial ratios do not give us a “yes/no” answer about an individual stock. Rather, we treat financial ratios like a stew of information that gives us a more rounded analysis of our potential investment and allows us to compare our stock with its competitors and the market as a whole. The financial statements that we utilize to compute our financial ratios are also very handy whenever we are experiencing a bit of sleeplessness. Just ask any accountant's spouse!

Presentation file - Study guide

5.1: Financial Statements
Every publicly-traded corporation must publish their financial statements every three months. The three financial statements are the Balance Sheet, the Income Statement, and the Cash Flow Statement. Luckily, the accountants are tasked with creating the financial statements. We investors just need to learn how to read them and pick out the important elements. We use the financial statements to create financial ratios that help us "round out" our research into our potential stock investments.
5.2: Common Stock Ratios
The Common Stock Ratios convert key information about a firm to a per share basis. Most are readily available from all stock information sources.
5.3: Profitability Ratios
The Profitability Ratios are popular ratios that measure a firm’s returns by relating profits to sales, assets, equity, and invested capital.
5.4: Liquidity Ratios
Liquidity Ratios measure a firm’s ability to meet its day-to-day operating expenses and satisfy its short-term obligations as they come due. "Can we make payroll this week?"
5.5: Activity Ratios
Activity Ratios measure how well a firm is managing its accounts receivable, inventory, and total assets.
5.6: Leverage Ratios
Leverage Ratios are used to measure the amount of debt being used to support operations and the ability of the firm to service its debt.
5.S: Summary
Congratulations ‒ You Have Finished Chapter 5 ‒ Fundamental Analysis: Financial Statements and Ratio Analysis