Stock market concepts-2

Annual Report
What is an annual report and why is it useful to investors?
An annual report provides a company's shareholders with information about its operations. This is an obligation stipulated by law. This is extremely beneficial to investors because it helps make informed decisions.The report tells you how well the company is doing while also forecasting its future earnings and dividends. The Chairman's letter in the report also profiles the company's future goals.
Inside the Annual Report
Here is what comprises an annual report:
* A letter from the chairman on the high points of business in the past year with predictions for the next year.
* The company philosophy: A section that describes the principles and ethics that govern a company's business.
* An extensive report on each section of operations within the company, describing the company's services or the products.
Financial information that includes the profit and loss (P&L) statements and a balance sheet. Depending on its income and expenses, the company will either make profits or show losses for a year. The balance sheet describes assets and liabilities and compares them to the previous year. The footnotes will also give you reveal important information, as they discuss current or pending lawsuits or government regulations that may impact the company operations.

* An auditor's letter in the annual report confirms that the information provided in the report is accurate and has been certified by independent accountants.

How do I obtain an Annual Report?
Annual reports are mailed automatically to all shareholders on record. If you wish to obtain the annual report about a company in which you do not own shares, you can call its public relations (or shareholder relations) department. You may also look at the company web site, or search the Internet; as there are several sources on the Internet providing information on public companies.
All publicly listed companies are required to submit the financial reports available in the public domain as per SEBI regulations.

What are quarterly and other financial reports?
Besides the annual report, companies provide several other financial reports such as a quarterly reports (issued every three months) and statistical supplements. These however are not as comprehensive as the annual report of the company.
Quarterly reports are very similar to the annual reports except they are issued every three months and are less comprehensive. They may be obtained in the same way as an annual report.

What are Company Earnings?
Earnings are a company's net profit. It is the surplus left with the company after it has cleared all its expenses, i.e. Money paid to employees, utility bills, costs of production and other operating expenses The manner in which a company makes its earnings, is defined by the very nature of its business.
For eg., a cement manufacturer produces cement for sale to its customers.
Two sources of company earnings are:
Ø Income from sales of goods or services
Ø Income from investment.
Investments generate income for businesses by way of either interest on loans, dividends from other businesses, or gains on the sale of investment property.Thus, company earnings are the sum of income from sales or investment left after the company has met its obligations.

Why are Earnings important to you as an investor?
As an investor who holds shares of the company, you have part ownership of company.When you invest in a company's shares, you become a 'part owner' of the company and you get to share a part of the company's profit as dividend. Thus, if the company does well and earns more profit, you in turn to well. If the company reinvents its earnings towards future growth, you are assured of higher dividends in the future.

Meanwhile, if you lend money to the company by investing in its bonds, the company uses part of its earnings to repay interest and principle on the bonds. The more earnings the company has, the more secure you can be that the company will be able to make your interest payments. So, company earnings are important to you because you make money when the business you invest in, makes money.

How do you use earnings information to make an investment decision?
Your investment goals determine how you use information about company earnings. If you are an income investor, interested in earning immediate income from your investments, you probably want to invest in a company that is paying dividends. If you have a long-term investment strategy, dividends may not be as important to you. The "financials" indicate whether a company is oriented for income, growth, or a bit of both. By comparing the financials for different companies in the same industry, you can find characteristics best suited to your investment goals.
A convenient way to compare companies is through Earnings per share (EPS). EPS represents the net profit divided by the number of outstanding shares of stock.
When you compare the EPS of different companies, be sure to consider the following:
Ø Companies with higher earnings are stronger than companies with lower earnings.
Ø Companies that reinvest their earnings, may pay low or no dividends but may be poised for growth.
Ø Companies with lower earnings, and higher research and development costs, may be on the brink of either a breakthrough or a disaster, making them a risky proposition.
Ø Companies with higher earnings, lower costs and lower shareholder equity, might go in for a merger.

How do I use Fundamentals to make an investment decision?
Fundamental Analysis is a method used to evaluate the worth of a security by studying the financial data of the issuer. But this research can never accurately predict how the company will perform in the stock market. It can however be used as a good comparative framework to know which company will be a better investment choice.
As an investor, you are interested in a corporation's earnings because earnings assure higher dividends and potential for further growth. You can use profitability ratios to compare earnings for prospective investments. These are measures of performance showing how much the firm is earning compared to its sales, assets or equity.
You can quickly see the difference in profitability between two companies by comparing the profitability ratios of each. Let us see how ratio analysis works.

What is Ratio Analysis?
The ratio analysis technique is also called cross-sectional analysis, providing you with important information about a company's financial strength. Cross-sectional analysis compares financial ratios of several companies from the same industry and enables you to deduce success, failure or progress of any business. Thus, a financial ratio measures a company's performance in a specific area and guides your judgment regarding which company is a better investment option. Some of the important ratios that an investor must know are:
1) Price-Earnings Ratio((P-E ratio):
It is a ratio obtained by dividing the price of a share of stock by Earnings per share (EPS) for a 12-month period.
2) EPS (Earnings Per Share):
It is that portion of a company's net income, which corresponds to each share of that company's common stock which is issued and outstanding. EPS gives an indication of the profitability of a company.
It is calculated using the formula:
EPS = Net Income-Dividends on Preferred Stock / Average Outstanding Shares
3) Current Ratio:
Companies need a surplus supply of current assets in order to meet their current liabilities. They generally pay their interest payments and other short-term debts with current assets. If a company has only illiquid assets, it may not be able to make payments on their debts. It is a type of Liquidity ratio.
Current Ratio = Current Assets / Current Liabilities
Leverage Ratios:
Traditionally, leverage is related to the relative proportions of debt and equity, which fund a venture. The higher the proportion of debt, the more leverage.It is a ratio that measures a company's capital structure, indicating how a company finances their assets. Do they rely strictly on equity? Or, do they use a combination of equity and debt? The answers to these questions are of great importance to investors.
Leverage= Long Term Debt / Total Equity

A firm that finances its assets with a high percentage of debt is risking bankruptcy, higher borrowing costs and decreased financial flexibility; if its performance cannot help fulfill its debt payments. If a company is highly leveraged, it is also possible that lender's may shy away from providing further debt financing fearing the viability of their investment.
The optimal capital structure for a company you invest in, depends on which type of investor you are. A bondholder would prefer a company with very little debt financing because of it lowers the risk of him losing his money.
When a firm becomes over leveraged, bankruptcy can result.
Shareholder's Equity:
Shareholders' equity is calculated as the value of a company's assets less the value of its liabilities. It is the value of a business to its owners, after all of its obligations have been met. This net worth belongs to the owners. Shareholders' equity generally reflects the amount of capital the owners invested, plus any profits that the company generates.
Bankruptcy:
Bankruptcy is a legal mechanism that allows creditors to assume control of a firm when it can no longer has the ability to meet its financial obligations. Both stock and bond fear bankruptcy. Generally, the firm's assets are sold in order to pay off creditors to the largest extent possible.

When bankruptcy occurs, stockholders of a corporation can only lose the amount they have invested in the bankrupt company. This is called Limited Liability. If a firm's liabilities exceed the liquidation value of their assets, (the value of assets converted into cash), creditors also stand to lose money on their investments.
Understanding the Balance Sheet
The balance sheet is one of the most important financial statements of a company. The logic behind producing a balance sheet is to ensure that the accounts are always in balance and all the company funds can be accounted for. It is reported to investors at least once a year. You may also receive quarterly, semiannually or monthly balance sheets.

The contents of a balance sheet include:
What the company owns (its assets)What it owes (its liabilities)The value of the business to its stockholders (the shareholders' equity).

Why should the Balance Sheet be important to you?
As an investor you need to ensure that the company you have invested in, has good potential for future growth and will yield good returns. The balance sheet helps you get answers to questions like:
· Will the firm meet its financial obligations?
· What amount of funds have already been invested in this company?
· Is the company overly indebted?
· What are the different assets that the company has purchased with its financing?
These are just a few of the many relevant questions you can answer by studying the balance sheet. The balance sheet provides a diligent investor with many clues to a firm's future performance.
What are Assets?
Assets are any items of economic value owned by a corporation that can be converted into cash.
Types of Assets:
Current assets are assets that are usually converted to cash within one year. Bondholders and other creditors closely monitor a firm's current assets since interest payments are generally made from current assets. Also incase the company goes bankrupt, assets can be easily liquidated into cash and help prevent loss of your investments. Current assets are important to most companies, as they are a source of funds for day-to-day operations. It is thus evident, that the more current assets a company owns, the better it is performing.

Cash equivalents are not cash but can be converted into cash so easily that they are considered equal to cash. Cash equivalents are generally highly liquid, short-term and very safe investments.
Accounts Receivable:
Accounts receivable is the money customers (individuals or corporations) owe the firm in exchange for goods or services that have been delivered or used but not yet paid for.As more and more business is being done today with credit instead of cash, this item is a significant component of the balance sheet. Accounts receivable is however recorded as an asset on the balance sheet as it represents a legal obligation for the customer to remit cash.
Inventory
A firms inventory is the stock of materials used to manufacture their products and the products themselves for future sale. A manufacturing company will often have three different types of inventory: raw materials, works-in-process, and finished goods. A retail firm's inventory generally will consist only of products purchased that are still to be stored. Inventory is recorded as an asset on a company's balance sheet.
Long-term Assets:
Long-term assets are grouped into several categories like:

A long-term, tangible asset held for business use and not expected to be converted to cash in the current or upcoming fiscal year, such as manufacturing equipment, real estate, and furniture.

Fixed assets are long-term, tangible assets held for business use and will not be converted into cash in the current or upcoming year.

Eg. Items such as equipment, buildings, production plants and property. On the balance sheet, these are valued at their cost. As the value of the asset declines over the years, depreciation is subtracted from all, except land. Fixed assets are very important to a company because they represent long-term investments that will not be liquidated soon and can facilitate the companys earnings.
Depreciation gives you an estimate of the decrease in the value of an asset, caused by 'wear and tear' or obsolence. It appears in the balance sheet as a deduction from the original value of the fixed assets; as the value of the fixed asset decreases due to wear and tear.

Intangible assets are non-physical assets such as copyrights, franchises and patents. Being intangible, it becomes difficult to estimate their value. Often there is no ready market for them. Sometimes however, an intangible asset can be the most valuable asset a company possesses.

What are Liabilities?
Liabilities are a company's debt to outside parties. They represent rights of others to expect money or services of the company. A company that has too many liabilities may be in danger of going bankrupt. Eg. Bank loans, debts to suppliers and debts to its employees. On the balance sheet, liabilities are generally broken down into Current Liabilities and Long-Term Liabilities.
Types of Liabilities:
Current liabilities
Current liabilities are debts currently owed for taxes, salaries, interest, accounts payable* and notes payable, that are due within one year.
A company is considered to have good financial strength when current assets exceed current liabilities.
*Accounts Payable
Accounts payable is one of a series of accounting transactions covering payments to suppliers whom the company owes money for goods and services. Therefore, you will often see accounts payable on most balance sheets.
Long-term debt is a long-term loan, for a period greater than one year. These debts are often paid in installments. If this is the case, the portion to be paid off in the current year is considered a current liability.