Motley Fool Answers' July Mailbag: Is There a Quick Guide to Reading Corporate Financial Statements?
If there's one thing Motley Fool Answers hosts Alison Southwick and Robert Brokamp enjoy, it's hearing from their listeners, so they particularly relish the monthly mailbag episode. But even they can be overwhelmed by the quantity and breadth of those queries, so this time around, they've invited a couple of friends to help out: serial podcast guest Jason Moser and Answers newbie Abi Malin.
In this segment, they help a listener who wants to delve into the corporate financial statements of his investments. There are a number of options, but one particularly good choice is the SEC's offering on the the subject.
A full transcript follows the video.
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This video was recorded on July 31, 2018.
Alison Southwick: The next question comes to us from Anthony. "My question is about financial reports, specifically balance sheets and income statements."
Jason Moser: Nerd!
Southwick: And you mean that as a compliment, I know, from one nerd to another.
Moser: Hey, listen. I am extremely self-effacing when it comes to this and yes, I am extremely nerdy when it comes to this stuff.
Southwick: Then it sounds like this question is coming to you. "I want to sound like one of the smart folks when it comes to explaining my stock picks, but I never feel confident when it comes to reading their financial filings. Is there a quick reference guide that breaks down the categories? PS. One of my wedding couples told me they listen to all The Motley Fool podcasts so, Noreen and Ryan, this letter is from me." Hello, Noreen and Ryan.
Moser: Well, a tip of the cap to Anthony. Nerd jokes aside, that is a great question. If you're going to invest, particularly in individual stocks, this is a great skill set to have. It's not necessarily an easy one to get. I had the good fortune of going through an analyst development program here at The Fool eight-and-a-half years ago, and we focused a lot on learning how to read financial statements. It can seem very boring and dry to a lot of people but understanding how the numbers work gives you a better understanding of how the business works and what kind of growth may be there, and that all relates to the stock price.
There are a lot of different places you can find this stuff. You can go to Google and just search "financial statement education" and find a million different resources. That's one way to look at it. Specifically, there is a good page on the SEC website with a nice, succinct rundown of the three main statements, there,income statement, balance sheet, and cash flow statement. Now I can't give you the link, because it's really long and I can't rattle off all these letters and numbers, but I can tell you if you Google the phrase "SEC Guide to Financial Statement," that will take you to this page and we'll send out the link on the Motley Fool Answers Twitter feed.
Southwick: Oh, man. Now I've got to put out a reminder.
Moser: Don't worry. I've got your back already on this. I was going to remind you.
Southwick: You're going to do it?
Moser: Sure!
Southwick: I have homework!
Moser: This is a great resource to go through and learn the basics of those three financial statements. And I think, Anthony, that's what you're really gunning for, here, is a nice introduction that will give you, then, the opportunity to dig a little bit deeper, ask some more questions, and try to figure out what is more important. They are very important statements to understand how to read if you're going to invest in individual stocks.
And one other resource I'll just throw out there is the SEC has a neat, little educational Twitter feed and that is @SEC_Investor_ED. They throw a few tweets out every day. They run all over the place with investor education. I think it's a fun one to follow. I always learn something new when I check that out.
Abi Malin: I would add to that a little bit. If you are new, I think something that would help you gain confidence in what you're looking at is to read other people's pitches or stock ideas. I would recommend starting in one industry -- something you may know a little bit better or something maybe a little bit easier -- like consumer goods. A familiar company like Starbucks, Target, or whatever it is. Just reading through other people's pitches so you can get familiar with what people are looking for and what people are looking at.
Southwick: What do you mean by other people's pitches?
Malin: Motley Fool has them or Seeking Alpha. If you read someone's opinion about a different company, I just think looking at what people are using for metrics in particular industries can be a little bit more comforting than just taking in a lot of information about metrics.
Moser: That's a really good point. If you think about it, a lot of businesses focus on very different markets, which means their financial statements account for different things. You might have a subscription service that has deferred revenue involved. Then you may have a straight-up restaurant which is fairly simple. They're selling food to people. So understanding the market that you're focusing on is going to help dictate what is more important to folks on one of those financials.
Southwick: It sounds like the point of his question is how to also sound like he knows what he's talking about at those proverbial cocktail parties that we don't get invited to. Is there any clue when you hear someone talking about investing where you're like is this person just using a lot of accounting terms to sound smart and they really don't know what they're talking about?
Moser: Well, I was thumbing through the cash flow statement last night and I noticed that accounts receivable went up over the last year.
Southwick: Any advice for Anthony to call out the posers in the room?
Moser: Well, if you're looking to call out people, there's always ways to do that. I would just encourage you, Anthony, to know what you're talking about. If you don't know something, it's OK to not know it. Go find the answer. We do that all the time. Don't try to answer a question where you don't know the answer. Just say, "I don't know," and then go look it up and figure it out.
Understanding what line items are on what financial statement probably makes the most sense because they don't all have the same things. Whether you're talking about cash flow or net income, understand the differences between the two because they are different.
Some investors like to focus on cash flow because they feel like there's some noncash charges involved. They give you a better idea of how much money the company's actually making vs. net income, which accounts for things a little bit differently. So just getting in there and understanding how all of the parts work to the whole on each financial statement, because they are different and they each serve their own purpose.
Southwick: I found that I really have to treat learning accounting terms like learning a new language. It's like learning a whole new language...
Moser: It is...
Southwick: OK, what is that again? And I have to stop and think. It's like having to remember, "OK, a put is..." It's me having to remember options terms, too. I have to pause. "OK, so I think the stocks going to go..." I'm not fluent.
Moser: Well, it's not easy, and the only way to really be good with a language is to study it.
Abi Malin owns shares of Starbucks. Alison Southwick has no position in any of the stocks mentioned. Jason Moser owns shares of Starbucks. The Motley Fool owns shares of and recommends Starbucks. The Motley Fool has a disclosure policy.
