How to Value Stocks: How to Read a Balance Sheet
Publicly traded companies are designed to make money. To find successful stocks, most investors examine a company's ability to grow its various types of earnings. But there's another, clearer way to suss out a company's real value: look at the liquid assets on its balance sheet.
Balance what? Liquid who?
The balance sheet is a record of a company's assets and liabilities -- in short, what it's already got or expects to get soon, and what it owes to others.
Shareholder value ultimately comes from liquid assets -- assets that can easily be converted into cash. The amount of liquid assets a company can amass ultimately determines its value. Better yet, if a company generates more liquid assets than it needs to fund its operations, it can give the excess back to shareholders in the form of dividends or share buybacks.
There are two ways to measure liquid assets. The first is terminal value -- how much the company would return to shareholders if, at some future point, it closed down all its operations and turned everything into cash. The second is tangible shareholder value -- the returns on invested capital generated by the company's operations.
Most investors spend too much time obsessing over a company's earnings, and too little time studying the balance sheet and its cousin, the statement of cash flows. The balance sheet can tell you whether a company's got enough money to keep funding growth, or whether it'll have to take on debt or issue bonds or additional stock to sustain itself. Does a company have too much of its money tied up in inventory? Is the company collecting money from its customers reasonably quickly? The balance sheet knows all.
Where can I find the balance sheet?
Believe it or not, you can get it for free. The Securities and Exchange Commission (SEC) and its EDGAR website give you all sorts of balance sheet information in a company's 10-K and 10-Q reports.
The 10-K is a toned-down, once-a-year version of a company's annual report, with more text and fewer pretty pictures; it contains the company's balance sheet for the entire fiscal year. The 10-Q is a quarterly filing that a company makes with the SEC three times a year (the fourth yearly filing is the 10-K). The 10-Q reports also track a company's balance sheet through the course of the year. Note that unlike its quarterly compatriots, the 10-K's balance sheet is double-checked by accountants before it's filed with the SEC.
Now that you know what a balance sheet is, why it matters, and where to find it, you're ready to dive in.
More on reading a balance sheet:
- Current Assets
- Current Liabilities
- Debt and Equity
- Current and Quick Ratio
- Working Capital
- Price-to-Book Ratio, DSO, & Turns