|
Income Statement Analysis
- Great companies and good
EPS growth
do not guarantee
stock market profits
- The P/E ratio can create
buying opportunities
-
Mishaps can create steals
- Unusual charges reduce the
value of your stock
- ROE is the single best tool
for investors
- ROA is another valuable tool
- Investors pay for high profit
margins
- Lenders can eat up all the
profits
- Depreciation creates
deferred taxes, which have
equity-like qualities
- EPS is a complicated
calculation
|
|
Mishaps can create steals
Many buying opportunities present themselves when
companies report unusual charges, and their stock prices drop to
unrealistically low levels, while their future earnings capacity remains
intact. Moreover, the potential upside can be compounded in a down market.
Buyers need to understand the charges and their future impact on the
business. Being able to act under adverse conditions is essential. The best
scenario is when “good” companies (best of breed) stumble, in a soft market,
creating buying opportunities that would otherwise be unavailable.
Differentiating between “good” and “bad” companies is
a skill. The risks are high. The bad companies may never go back up in
value; their problems tend to mount. It can get bloody trying to “catch a
falling knife.”
The key is
only to invest in quality companies with demonstrated histories. Some of the
aerospace and defense companies, like Lockheed Martin and Raytheon, for
example, suffered multiple business setbacks in the late 1990’s, only to
subsequently recover, principally because they were well managed
organizations with recurring customers. Seal Air and Fresenius Medical Care
are additional examples. Their stocks fell sharply in 2002, mainly because
of their exposure to W.R. Grace’s asbestos litigation. This created two very
good investment opportunities in excellent companies at attractive prices.
In essence, you are looking for a “best of breed” company that has
temporarily stumbled, with the market negatively overreacting. In a weak
market, the downside can be magnified, resulting in fantastic buying
opportunities. |
|
