Financial analysis is the basis to set up a predictable and reasonable market price for the respective stock. This becomes the sell price point or what is often referred to in this series of lessons as the recovery point. If all three forces (economic, industry and company level) are performing reasonably, then the stock price for the company will recover to this sell point within a short period of time. Therefore, it is important for value investors to understand the importance of having knowledge about financial analysis.
Financial analysis is an assessment of a company’s performance in the form of dollars. The goal is to establish a trend line of financial accomplishments. It is safe to assume that the historical results can predict future results with accuracy. Again, large corporations are money generating machines; it will take several adverse actions to slow down or diminish the ability to earn profits.
Financial analysis starts with gathering research data, specifically annual and the most recent quarterly financial reports. With this information, certain data is loaded into a spreadsheet so that ratios can be determined. With the spreadsheet data, trends are tracked and from there, summarized. This summary of pertinent outcomes assist the value investor with determining the most likely outcomes for the next several quarters. Take note, value investors are not as interested in extended time frames as this methodology is designed to determine an expected recovery value for the stock in the short-term. Value investors are not interested in holding to collect dividends, there are interested in the buy low, sell high tenet of business. Thus, long-term expectations are irrelevant.
Other key information is extracted from the quarterly and annual reports to confirm trends, validate business ratios and finally, determine the expected market recovery price.