Hey Friends. In 2013, my book, “Choose Stocks Wisely,” was published. Its emphasis is on the balance sheet as the starting point for stock investment analysis. Why this emphasis?
Simply, a common stock share is an ownership share in a company that is constituted as a corporation. It is a share of the equity since equity refers to the value of what is owned. Friends, there are people jumping into gold and silver investment right now because they are worried about the fundamental support underlying our nation’s financial standing. I mention this because it only serves to drive home the importance of never buying a stock without evaluating the subject company’s fundamental equity support.
Equity is a term that is synonymous with net worth. Equity is also synonymous with net assets; and, again, also synonymous with book value. In stock investment analysis, the label “net assets” is focal because the balance sheet is the financial statement that breaks down the net asset position. The excess of assets over liabilities equals net assets (equity). The composition of the assets is extremely important to investigate since one buys stocks with cash and needs to have some idea of the cash value of the net assets being purchased. How else could one ever have any confidence about buying low?
So, stock investment analysis starts with the balance sheet. Or, perhaps I should say that stock investment analysis should start with the balance sheet. In reality, very often, stock investment analysis jumps past analysis of the net asset position and goes to directly to the earnings being generated by the company’s net assets.
Starting analysis with the balance sheet does not preclude careful analysis of the earnings history and earnings expectations — certainly not! But without the balance sheet evaluation, earnings cannot have any context in valuation of an equity investment like common stock.
When buying a stock, I want to first know how much equity value already exists, aside from future earnings. The more net assets I can acquire for my money, the better. Why? Because I want to buy low and I want all the asset support underlying my investment I can get in case earnings don’t pan out as projected. Earlier I stated the composition of assets on the balance sheet is extremely important. Not all assets are equal when it comes to assessing their value in dollars and cents. My book deals with how to assess value of assets based on their composition.
Like most things in life, it pays to revisit the basics often. If one forgets that a share of stock is a share of equity, he/she might regard only earnings as the basis for buying and selling. But it is always the net asset position which offers the primary defense against risk of default. Default on an investment can ruin a portfolio because a total loss leaves nothing to invest elsewhere to recover and move forward. Losses in the stock market are not avoidable altogether. Anyone who tells you otherwise isn’t speaking the truth. However, losses can be avoided better and be reduced — and default risk can be made extremely rare — by starting stock investment analysis via studying the balance sheet. Reducing losses permits better net gain scenarios for stock portfolios in the end. Again, the primary reason behind my book, “Choose Stocks Wisely,” is to show how the balance sheet can be studied before purchasing an equity investment in a corporation (i.e., common stock share).
See you next time. And have a wonderful Labor Day, friends!
In both your liquidity test and solvency test you specifically designate “cash.” I was wondering if I can use, “cash, cash equivalents, marketable securities instead?”
Hey Steve. If you go to page 122 of the book, half way down where it starts “Make a mental note…” or to page 127 near the top where it starts “Cash…,”
you’ll note it states to merge cash and short term investments together as “cash.” These book pages are on the chapters illustrating my scorecard methodology. So, yes, indeed, use the cash, cash equivalents and marketable securities as the proxy for “cash.” That is exactly what I do and is intended in the application described in the book. I’m glad you made a comment with this question because it is one of those things worthy of clarity and double-checking oneself.
Thanks so much for your continued help and support.
You’re welcome. And I really appreciate your support of my efforts to add something of value to the challenge of investing in the stock market! Have a great week.