- Let's summarize what we've learned
about financial statement analysis.
First, there's a four-step process.
- It starts with return on equity and the DuPont framework.
With the DuPont framework we look at that return on equity
and decompose it into profitability,
efficiency, and leverage, those three dimensions
because we know that all three of those
affect a company's return on equity.
- To then find out a little bit more detail
about profitability, efficiency, and leverage,
we can then use common size financial statements.
- In my opinion, the common size financial statements
are the single-most efficient tool
at getting insights into a business.
- Look at the common size balance sheet,
the common size income statement.
From there, we've identified efficiency
or leverage or profitability problems
we can then drill down with some specific ratios,
with profitability ratios, efficiency ratios,
and leverage ratios.
- Finally, all of this is to prepare us for step four.
We need to talk with some people.
Those are the four steps
in the financial ratio analysis process.
These four steps allow us to identify
where issues for a company might be
and what we might do to determine next steps.
- If you're outside a company you do
financial statement analysis to make a decision,
such as should I make a loan to a company?
- Should I invest in a company as an owner?
Why is this company's profitability different
from the industry benchmark?
- There are lots of why questions,
and really, that's a key insight
with financial statement analysis.
The numbers lead you to ask more questions about why.
- Now, Ken and I are always asked, can I use my knowledge
of financial ratios to pick stocks in the stock market?
- Okay, quick answer, no you cannot.
There is no credible financial research
that has ever shown that financial ratio analysis
can help a person pick winning
and losing stocks in the stock market.
- Now why is that?
Well, the market's too fast.
There are smart people in New York and Tokyo
and London and Hong Kong who are scouring information
about companies every day,
and when they get a new piece of information,
accounting information, it's reflected in the stock price
in 15 minutes or less.
- So you and I using one month or two month
or six month old financial statement data
doing ratio analysis, we cannot pick
winning and losing stocks, it's too slow.
- So now you're asking yourself, well, why do we learn about
financial statement analysis then anyway?
- Well, it's for this reason.
In the United States, for example,
there are 4,000 publicly traded companies.
And what we just said applies to those companies,
those 4,000, you cannot use financial ratio analysis
to help pick winning and losing companies
among those 4,000.
But overall, in the United States
there are 15 million companies,
private companies, that are not publicly traded,
and it's often the case that the only source
of reliable information about those companies
are the financial statements
and the financial ratio analysis
that we've been learning about in this course.
So please realize that yes, it's true,
you cannot pick stocks using financial ratio analysis,
but you can identify good companies,
bad companies, healthy companies,
companies with problems using financial ratio analysis.
- And it's those private companies,
those small to midsize companies,
the companies that you might be asked to work for,
to invest in, to loan money to, to manage.
- Now the whole point of financial ratio analysis
is to show you where the issues are.
The numbers put you right there.
- The numbers put you in the right room
with the right people asking the right questions.
You are an informed person as you go into that room
because you've done your financial analysis.
In the end, of course, you're going to need
to use your business judgment to make the decision.
But you've got the big picture
with your financial ratio analysis.
You're right there with the people at the decision table,
armed with your financial statement analysis.
- You're ready.