How to Read a Financial Statement (Part 1)

Having discussed the basics of both fundamental and technical analysis strategies, I believe that the next step for the investors is to learn how to read financial statements of a company. By reading, I mean the investors should be able to understand not only the profit and loss of the company, but also other important info which are ‘hidden’ in the statement. By analyzing the statement, investors will be able to select and filter companies that have the most growth potential.

Earning Per Share (EPS) Ratio

Earning per share (EPS) ratio is used to measure the company’s earning for every shares issued. The company’s earning power will show us how well the company is doing over the years. Based on the EPS ratio, we can also calculate the company’s growth rate from the previous year. It is recommended to find companies that have at least an average of 15% of EPS growth rate for the last 10 years.

EPS =          Net Profits -  Pref Dividends
                          No of Ordinary Shares

EPS Growth (%) =EPS for current year X 100
                               EPS for previous year

Return On Equity (ROE)

Return on equity reflects the company’s efficiency in utilizing the shareholder’s fund for the maximum profit. The higher the percentage, the better the company in utilizing the fund provided to them in making the most profit. Like EPS Growth, it is recommended for investors to find companies with proven track record of at least 15% average ROE for at least the last 10 years. 

ROE =      Net Profit – Pref Dividends X   100
                       Shareholders Fund

Price per Earnings (PE) Ratio

Price per earnings ratio is the comparison of the stock price with the company’s earning to determine how fast we can recoup our capital, if there are not any changes  to the stock market. If the company’s PE ratio is 10, then we will need 10 years to recover our initial investment. So, the lower the ratio, the better the company. In determining whether the PE, we must also compare the company’s PE ratio with other company’s  PE ratio that involves in the same industry. It is not fair if we compare the PE ratios of Maybank with AirAsia, simply because they are in two different industries. Maybank’s PE ratio should be compared with the likes of CIMB, Public Bank or Hong Leong Bank.

PE Ratio =                    Share Price     
                                  Earning Per Share

to be continued…

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