Analysis of financial information for stock valuation

Valuation of a company in terms of its shares is a long and effort-taking process. Yet individual investors will find it helpful to get to know about the main stages of the process as they can perform nearly all of the stages on their own.

When analyzing a company one should first get all its financial information, including the latest 10-K and 10-Q reports, annual report, top executives compensation report, industry reviews and analyst reports. It is strongly advisable to keep pace with the new information in Internet concerning the company or the industry. This stage is important for preliminary valuation of the company’s stock.

After all the necessary information is collected, the analyst examines and compares cash flow data within 10-K and 10-Q reports. Cash flow report is the most reliable financial report as data gerrymander is next to impossible.

While examining cash flow from operations, one needs to keep several questions in mind. Do positive cash flows result from core business operations? Is cash flow growing? Which cash flow components signal about growth/decline? What is the key factor for the company’s growth: additional financing and investment or earnings from current operations? Examining cash flow data for the latest eight quarters gives the opportunity to establish the major tendency for growth, stagnation or decline.

The next step is the analysis of the company balance sheet. Experts perform full analysis based on the financial ratios computed using the latest eight quarters’ data. The financial relationships include current ratio (relationship between current assets and current liabilities), quick ratio (relationship between the current assets excluding finished goods and work in progress inventories), receivables turnover period, inventory turnover, debt-to-equity ratio, debt-to-asset ratio, etc. Computing the ratios, the analyst needs to find the trends: is the inventory turnover period increasing or decreasing? How effective does the company manage the relationship between borrowed funds and funds generated by its own activities? After that financial ratios are juxtaposed with the latest financial data for the company, which helps to assess its financial stability.