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Looking Beyond Financial Statement – Investor’s Perspective
In today’s highly competitive and inflationary but low interest environment, we are not only compelled to invest wisely to get much higher returns than the rate of inflation, but also need to perform exceptionally well to cope with the fast paced economy. Otherwise, financial freedom will not be within our reach.
Stocks investment is a widely used tool, growing in an un-precedented scale and still growing despite it has already formed one of the major investments in any economy.To reap the maximum return, investors are going through much greater lengths to cleverly create and craft strategies, such as "Japanese cloud" formations and "economic surprise" indicators. However, no methodology seems to work all the time.
Contrary to speculation, there is one strategy that absolutely never fails to boost returns, and is often overlooked: value investing. The concept of value investing appeals to those who are relatively conservative and persons who prefer making decisions on analysis of the basic financial strength of a company, coupled with a search for bargain prices of shares. This profound investment strategy requires discipline and patience. It will reward such investors consistently. It is a valuation technique, a technical strategy, or a way to predict funds that will outperform market.
Research, Research, Research
The phrase “past performance can’t guarantee future performance” may sound familiar to some of you. It sounds true even in today’s market. Future is hard to predict. Seeking investments conforming to assumptions or projection about the future without considering the basic facts about a company’s strength or growth potential is unwise. Fundamentals are king. Past performance still can be good indicators that reflect the quality of its management. Financial health is equally important to serve as a rock foundation to assist the company to endure through tough times and grow further.Research, research and research is important to uncover those stocks that trade below its fair price and have great potential. So, financial literacy can’t be viewed as “spare wheel”, but “steering wheel” instead.
BACK TO BASICS
As such, good and sound understanding of finance literacy is critically important in helping the investors to make better informed decisions of their investment. It is not just business acumen. It forms a small fraction of the business yet it is significant, just like the rudder that navigates the planes and ships.To a great mind, nothing is too little. By mastering it, you are able to assess its financial health correctly, comfortably and confidently especially in regards to an adequately capitalized company and its free cash flow.
Free Cash Flow
What is free cash flow? It tells an investor how much actual cash a company is left with after any capital investments. For instance, companies that have high debt/equity ratios, especially in an industry facing tough times, naturally could be one of your first signs that a company is getting over its head in debt.
Do your home work
Read and understand annual reports carefully and assess how Management addresses those critical and concerned areas that significantly affect the companies arising from external changes. What is the quality of assets that had been invested to build or strengthen their competitiveness? What compensation plans have been put in place to retain key and talented personnel? That’s the main reason why we need to look beyond financial statements to weed out those potential growth stocks that are trading fairly lower than their intrinsic value. By looking at the bigger picture of the business such as its competitive position, product or service trends, economic and technological forces that affect its future value, you are able to select those appropriate stocks for investment. What matters most is the quality of management of the company. This is because the management serves as the brain of the company, who will respond to the endless changing environment and navigates the company to the next level of success.
Value investors focus on individual company; review its history of growth, corporate announcements and news inside out, conduct field work, raise material questions during the annual general meeting and extra-ordinary meeting if appropriate. You need to gather those findings, prior to the determination of its fair value that meets your selected criteria. It sounds simple and logical, yet it is not easy. Once the true value of a company has been determined, the value investors will look for a buying opportunity. This means they will buy stock in a target company only if they can execute an order below its pre-determined fair price.
The question arises whether such bargain arises in the market? Such stocks are in existence even in the efficient market when their potentials are unnoticed. You need insightful information to make accurate assessment of its fair value.
WHY LOOK BEYOND FINANCIAL STATEMENTS
Many investors claimed that they are long-term investors, but how many of us truly are? How many of us are really unshaken by a market nosedive or a threatening global event? The stock market is a psychological conundrum, and we're all vulnerable to its clever head-fakes. Perhaps we need to learn and master more of our mind faculties to overcome such fear before we invest. Short-term market trends are extremely chaotic and choppy. The good news is that long-term trends rely on the fundamentals.
We should cultivate discipline to be a better skilled investor. We should act contradictory to the other investors by accumulating those bargains stocks after downside panics, hold on while the market climbs and rebalance back to our asset allocation when everyone is bragging about their gains.
You need the “know how” to stay ahead. Have you ever wondered what intelligent approach or sound reasoning you possess before you buy that particular stock? Or is your decision just purely based on a simplistic indicator. For example, a company is about to secure a new project or is going to benefit from new legislation. However, under the value investing approach, you need to have control when you apply the rules. You will seek the series of answers of the following profound questions before you act:-
a. is the stock currently traded under its fair value?
b. what criteria determine this conclusion about valuation?
c. is the company dominant in its industry?
d. what is its recent price history?
In the long term, stock prices tend to move in line with the company earnings. It’s really that simple. Look at its past earnings trends and determine whether those trends will likely to continue into the future. Value investors need to track earnings;and not on many lists of “stock to buy.” The rationale is that it is most probably undervalued and the cyclical nature of this sector will come around again.
Excellent reputations for quality of management, products and competition are key ingredients for the value investment. A value company is most likely to have a strong domination in the industry. Always remember bargains show up in the market all the time because of the short-term irrationality of buyers and sellers.
Even during the market downturns, value stocks tend to perform better than average, either declining less than average or even rising. In 2008, one of the worst years on US record, McDonalds rose in value while nearly all other stocks prices decline.
This does not mean that value stocks are exempt from price declines. However, well selected value stocks do tend to outperform the market as a whole over the long term. A second source of returns on a portfolio, apart from price appreciation, is dividend income. This may not be for those who desire fast growing stocks. Value investors can make the most of dividend yield by reinvesting dividends in purchase of additional shares rather than taking payments in cash.The value investor is most probably more conservative and concerned with volatility than growth investors.
Hence, it is safe to conclude that to invest intelligently and wisely, one needs to look beyond the financial statements in order to make better informed investment decisions. With the financial mastery, coupled with insight knowledge and appropriate mindset, the chance of succeeding in investment is definitely relatively much higher. To save in the bank and earning its fixed deposit’s rate is definitely a loser. This is because the interest rate is much lower than the real inflation’s rate.
As such, every investor needs to develop a series of strategies for investing. An investment strategy is a set of rules, behaviors or procedures, designed to guide an investor's selection of an investment portfolio. Usually the strategy will be designed around the investor's risk-return tradeoff: some investors will prefer to maximize expected returns by investing in risky assets, others will prefer to minimize risk, but most will select a strategy somewhere in between.
At the end of day, every investor wants to make a profit. But without an investment strategy, how do you know which stocks to buy and which are too risky? How long will you hold those stocks?
To ensure that you achieve your goals with much certainty and consistency, looking beyond financial statements is unavoidable. Always begin with a strategy and vision, end with model and analytical insights. Stay focus on the big picture without losing the details by measuring, monitoring, managing them effectively and closely in line with the saying, “you can’t manage what you don’t measure.”
Uncovering the realities that lie behind the data is what business analytics is all about. You need to use your mind faculty to recognize those competitive edges, usually hidden to the casual observer, in those companies you have invested in.
In summary, by mastering the investment skills, you are able to handle your own investment with full accountability and commitment. “The whole science is a refinement of everyday thinking.” Albert Einstein. This is because a man’s world is a projection of his mind. When your mind is weak, you see problem. When your mind is balance, you see the challenge. When your mind is strong, you see the opportunity. So this sound, sane and solid principle also applies to investment as well.