Your analysis of a company's financial results should be based on the right parameters as it leads to making or losing money.
Understanding financial results is a very important task for an individual investor. This is vital to know the various changes taking place and how the performance will impact the share prices of companies. Several factors should be considered while doing so, to ensure the corresponding investment decisions are based on strong and valid fundamental factors. Here are some ways to do so.
COMPARISON
Any financial figure has no meaning on a standalone basis. So, if the information is that sales of a company are Rs 345 crore, while the profit is Rs 45 crore in the quarter ended September, or even if the sales and net profit are Rs 2,367 crore and Rs 456 crore, respectively, by itself it might mean nothing. The figures do not put the situation in context; this does not tell if the performance has improved or worsened.
The next question is on what has to be compared. One can compare the performance over a year earlier for the same period and this is called a year on year comparison. Valid when there are different situations through the year, especially in cyclical companies. For example, cement sales take a hit during the monsoon. Or, if sales of a company are concentrated during a quarter, then it makes sense to compare the position with that over a year earlier. This can be done for companies in areas like cement, sugar, fast moving consumer goods and so on.
The other option is to compare the situation with the position in the last quarter. This is valid when there are rapid changes in an industry and one has to be constantly abreast of the changes. Telecom companies or information technology ones where things are in constant motion need such a comparison to know the trend. Having the right comparison will ensure decisions are made effectively in a proper manner.
BASE
Apart from the right periods, what has to be considered is if the figures being compared are impacted by some specific changes. There are times when either an acquisition or a divestment results in a situation where some additional business has been acquired or a part of the business has been sold. If so, there cannot be a position where the figures for two periods are compared without adjusting for a common base. A 40 per cent jump in net profit might not reflect an improvement but be due to consolidation of figures of a company acquired. Once the common base has been secured, the real picture will emerge and this can be used effectively for the right kind of decision making. These situations are quite common because of increased merger and acquisition activity in the corporate world.
EXTRAORDINARY AND ONE-OFF ITEMS
A lot of variables impact companies and one always has to watch for extraordinary and one-off events; these can completely twist the position. Two items often found these days is of sale of investments and foreign exchange fluctuations. There are often several investments held by companies and the sale of a stake here often results in a large gain coming in. This can push up profits for the quarter and project a completely different position. There are two impacts to this, as initially the performance might look good without adjustments, but a year later, without such gains being present, the performance could look bad. Also, with a lot of dealings in several currencies, there are derivative instruments used for foreign exchange and an unexpected movement in the currency can so impact the company as to affect performance. It is vital that this is considered in context.
ACCOUNTING POLICIES
While a lot of the other points are evident, there is also the question of the accounting policies adopted. There are times when this is changed for specific items (investments, foreign exchange dealings, derivative instruments, etc) and, if this is not taken into consideration, the accounts would not present an appropriate picture. Profits have to be real and sustainable and not just rising due to book entries and hence the accounting policies also need attention. Once this is done, it will give a proper picture on the manner in which the company is performing.
All these factors might not guarantee that the investor will end by gaining from stock investments but it will at least ensure there is a proper base on which the decisions are made and will raise the chance of success.
The writer is a certified financial planner
