Great pointers from How to Read Financial Statements
- Debt: Ideally, you want to invest in companies with little or no long-term debt. This is generally a sign that a company has a healthy cash flow. Furthermore, the return on equity is substantially improved when a company is not burdened with interest payments on long-term debt.
- Return on Equity (ROE) Ratio: Return on Equity can be determined by taking net income and dividing it by total shareholder equity. This simple formula will measure the amount of profit a company generates relative to the amount of money shareholders have put into it. You will want to focus on stocks with a minimum if .15 (15%) ROE. Achieving a high ROE while incurring little or no debt is a sure sign of financial success. Be wary or companies that increase their ROE by increasing their debt which should be seen as a red flag.
- Profit Margins: It is an absolute must that a company's profit margin is on the rise. The ability to increase sales without a corresponding increase in expenses is characteristic of a solid company. Typically, the larger the profit margin, the safer the investment. Obviously, a company that operates with a 5% profit margin will operate at a loss if sales decline by 5%.
- Current Ratio: This ratio is determined by dividing the current assets by the current liabilities. This ratio will show you how well equipped a company will be at handling adversity. You should focus on companies with a current ratio of at least 2:1, preferably higher.
- Earnings: Quarterly earnings should show meaningful growth when compared to the same quarter from a prior year, not a prior quarter. This will insure that you are comparing apples to apples. Keep a keen eye out for one time extraordinary gains when looking at annual earnings. You will want to focus on companies with annual earnings growth of 20% or more.