LOOKING BEYOND FINANCIAL STATEMENTS – AN INVESTOR’S PERSPECTIVE
In today’s highly competitive and inflationary but low-interest environment, we are not only compelled to invest our money wisely to get much higher returns than the rate of inflation, but we 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 very widely used tools, growing on an unprecedented scale and still growing despite already forming one of the major investments in nay economy. To reap the maximum return, investors are going great lengths to create cleverly strategies such as "Japanese cloud" formations and "economic surprise" indicators. However, no methodology seems to work all the time.
VALUE INVESTING
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 priced 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 the market.
RESEARCH, RESEARCH, RESEARCH
The saying “past performance can’t be a guarantee of future performance” may sound familiar to some of you. It holds true even in today’s market. The 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 can still be a good indicator that reflects the quality of a company’s management. Financial health is equally important to serve as a foundation rock 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 their fair price and have great potential. So, financial literacy can’t be viewed as a “spare wheel”, it must be viewed as a “steering wheel” instead.
BACK TO BASICS
As such, finance literacy is critically important in helping the investors to make better informed decision regarding 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 a plane and a ship. To a great mind, nothing is too little. By mastering the rudder, 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 numbers, especially in an industry facing tough times, this naturally could be one of your first signs that a company is getting over its head in debt.
DO YOUR HOMEWORK
Read and understand annual reports carefully and assess how management addresses those critical areas arising from external changes that significantly affect companies. What is the quality of the assets that have 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 and economic and technological forces that affect its future value, you are able to select those appropriate stocks for investment. This is because the management serves as the brain of the company, which will respond to the endless changing environment and navigate the company to the next level of success.
Value investors focus on individual company, review its history of growth, and corporate announcements and news inside out, conduct field work and 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 the fair value price.
The question arises whether such bargain arises in the market. Such stocks are in existence even in the efficient price market when their potentials are unnoticed. You need insightful information to make accurate assessment of their fair value.
WHY LOOKING 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 better skilled investor. We should act contradictory to other investors 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 answers to 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 to a company’s past earnings trends and determine whether those trends will likely continue into the future. Value investors need to track earnings and not on many lists of “stock to buy.” The rationale of doing so is 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 a 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 other stocks prices declined.
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 the growth investors.
Hence, it is safe to conclude that to invest intelligently and wisely, one needs to look beyond the financial statements to make better informed investment decisions. With 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.
INVESTMENT STRATEGY
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 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 focused 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 mental faculties to recognize those competitive edges, usually hidden to the casual observer, in those companies you have invested in.
CONCLUSION
In summary, by mastering investment skills, you are able to handle your own investment with full accountability and commitment. As Albert Einstein said, “The whole science is a refinement of everyday thinking.” This is because a man world is a projection of his mind. When your mind is weak, you see problem. When your mind is balanced, you see the challenge. When your mind is strong, you see the opportunity. So this sound, sane and solid principle is also applies to investment as well.
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