Investing in Stock: Technical Analysis #2
Invest in a company with increasing "net cash provided by operating activities"
Before I explain my logic, here is my 30 second crash course on reading financial statements. There are three types of statements every publicly traded company produces:
Under the statement of cash flow, there is a line called "net cash provided by operating activities." In plain English this means how much cash the company is taking in vs. how much it is paying out (a positive number obviously means the company is taking in more cash than its paying out and vice versa if it is a negative number).
Balance sheets can be hard to read because there are line items such as goodwill or intangible assets which are hard to value or subjective (for example, how much is the name Coca-Cola worth?).
Income statements can be hard to read because there can be tax entries (such as depreciation) and one time items (a business is sold, inventory is liquidated) which makes it hard to determine the true profit of a company. As anyone who runs a business knows, a sale can be booked but the revenue never collected or not collected in whole or in a timely manner. However, the sale (subject to any bad debt write-offs) are booked as income.
Cash is cash. It is hard to manipulate the accounting on cash received. If the net cash provided by operating activities is increasing, this means the company has a lot of cash on hand. Cash allows a company to increase dividends, buy back stock, purchase competitors, invest in R&D- all the good stuff a growing company should be doing.
My favourite book on stock marketing investing is Morningstar's "The Five Rules for Successful Stock Investing" and to quote from it: "the statement of cash flow is the true touchstone for corporate value creation because it shows how much cash a company is generating from year to year- and cash is what counts"
As much as I hate reading financial statements, I make it easy on myself and go right to the net cash provided by operating activities line. It usually sheds a lot of light into how a company is performing.
Before I explain my logic, here is my 30 second crash course on reading financial statements. There are three types of statements every publicly traded company produces:
- Balance sheet: balances assets against liabilities (the difference is the total equity in the company)
- Income statement: basically a profit/loss statement
- Statement of cash flow: tells you how much cash the company is generating (or losing) year over year
Under the statement of cash flow, there is a line called "net cash provided by operating activities." In plain English this means how much cash the company is taking in vs. how much it is paying out (a positive number obviously means the company is taking in more cash than its paying out and vice versa if it is a negative number).
Balance sheets can be hard to read because there are line items such as goodwill or intangible assets which are hard to value or subjective (for example, how much is the name Coca-Cola worth?).
Income statements can be hard to read because there can be tax entries (such as depreciation) and one time items (a business is sold, inventory is liquidated) which makes it hard to determine the true profit of a company. As anyone who runs a business knows, a sale can be booked but the revenue never collected or not collected in whole or in a timely manner. However, the sale (subject to any bad debt write-offs) are booked as income.
Cash is cash. It is hard to manipulate the accounting on cash received. If the net cash provided by operating activities is increasing, this means the company has a lot of cash on hand. Cash allows a company to increase dividends, buy back stock, purchase competitors, invest in R&D- all the good stuff a growing company should be doing.
My favourite book on stock marketing investing is Morningstar's "The Five Rules for Successful Stock Investing" and to quote from it: "the statement of cash flow is the true touchstone for corporate value creation because it shows how much cash a company is generating from year to year- and cash is what counts"
As much as I hate reading financial statements, I make it easy on myself and go right to the net cash provided by operating activities line. It usually sheds a lot of light into how a company is performing.
Labels: Investement Strategy
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