My book, Choose Stocks Wisely, is simply about the balance sheet’s critical role to risk assessment as it relates to buying quality stocks at low prices. Yet, you rarely hear the balance sheet discussed when stock prices are the topic of conversation. Company earnings are always front and center and the balance sheet is not an earnings report but a statement about financial position and financial health.
Consider that my position on the balance sheet being central to risk assessment before buying stocks cannot change what is widely practiced in the market where earnings are used to determine when a stock price is low and when it is high. Nonetheless, my practice has allowed me to outperform the broad market, I believe, because I am using financial reports as intended. While earnings are my reward and, accordingly, the income statement (earnings report) will help me determine when a “high” price is achieved, earnings are not sufficient to tell me where risk is very low…..meaning the stock price is low.
If you want to find out how important the balance sheet is to risk assessment, just talk to a lender at any bank and find out how important a company’s balance sheet is before the bank extends credit to the company. I assure you that the lender has investigated the health of a company’s financial position, found only on its balance sheet. The lender intends to get paid back.
Simply put, the balance sheet enables one to find low-risk opportunities and therefore serves as a primary source for identifying quality stocks at low prices. The earnings of the company enable one to determine when a healthy reward is “baked into” the stock price and therefore serves as a primary source to define when selling stocks seems the sensible course to take.
I figure people who are reading a book like mine on the topic of stock investing are interested in stocks already. I’m trying my best to sell the critical role of proper risk assessment by using the primary financial statement intended to enable that risk assessment, namely the balance sheet. You want to do your best to avoid losing money and you sure don’t want to see the company you buy into go bankrupt. So, you have to buy quality and you want to buy it when it’s “on sale.” I’ll have a follow-up post on “Scorecard and Screening Talk……Relaxing More Filters”
Hello Dr. Allen,
Thanks for writing this book. It makes fundamental analysis a snap. I have always disregarded FA since I didn’t know what was important on a balance sheet and got the impression that I would have to spend countless hours pouring over company reports, financial statements and the like for each prospective company. The method outlined in your book makes it easy to score each company based on their financial fitness. I checked each company in my portfolio and found, much to my chagrin, that none of them would have been purchased using your methods. They were all purchased on technical buy signals. In the future I will try to blend the two methods into what Darvas called a techno-fundamentalist approach. Thanks again.