- All right, we have to be careful now.
There are potential pitfalls
associated with financial statement analysis,
and we've got to be aware of those pitfalls
so that we can carefully do our analysis
and carefully apply our results.
I can think of four things right off the top of my head
that we need to be careful about.
First, financial information
is not all the value relevant information
that's available about a firm.
Second, financial statements from different companies
are not sometimes comparable.
For example, let's look at ExxonMobil, a big oil company,
and Gazprom, the biggest natural gas company in the world.
If we were to look at their reported operating cashflows,
we would conclude that Gazprom, based in Russia,
generated more cashflow from operations than did ExxonMobil,
but it turns out that Gazprom
uses international accounting standards.
ExxonMobil was using the accounting standards
applicable in the United States,
so before we do comparisons
of financial statements from two different companies,
we've got to make sure it's apples and apples.
In addition,
not only when we're comparing international rules
with U.S. rules,
as was the case in this example,
but we also have got to pay attention
to how companies classify certain accounts
on their financial statements.
For example, Nordstrom, a high-end clothing store,
lists an item on its income statement:
costs of sales and related buying and occupancy costs.
This item includes more than just the cost of sales
listed on Walmart's income statement.
These two number just aren't comparable.
We have to make sure, when we do comparisons,
that it's apples and apples
when it comes to accounting methods.
We've just got to be careful when we're doing comparisons.
Third, a common mistake is
we always seem to be searching for one problem
when it could be that there's a multitude of reasons
a company is doing very well or doing very poorly,
and then the fourth common mistake
with financial statement analysis
is we weigh information differently.
We either look at history too much,
the distant past too much, or we anchor on the recent past.
It turns out financial statements
are only one part of the information spectrum.
There's lots of information
available about a company out there,
and while financial information is relevant and reliable,
it's not everything,
and the danger is
the precision of the financial statement numbers
can be very misleading.
We may think it's more important than it really is
because there are numbers attached to it,
so we have to be very careful
when using financial information
to not overweight it in terms of its importance.
For example,
for publicly traded companies in the United States,
company stock prices fluctuate every day
in response to all sorts of news:
economy-wide news, industry news, company-specific news.
News comes out every day,
and yet financial statements
come out once every three months
for publicly-traded companies.
We've got to make sure that we incorporate all information,
and not overweight the financial information.
Sometimes financial information, with its precision,
can lead us to assume that it's more important
than it actually is.