This is another continuation of my article 'How I Invest in Stocks'. This time, it is to address one subject I missed to elaborate further in Part 1 and Part 2; which is about the financial statement of a company. I decided to write about it because I believe many would ask the same question:
Do financial statement matters?
The answer is simple; yes but not 100%. Yes because what we're doing now is investing our capital in a company. Hence, logically you would want to invest in a company that performs well, not only in the short-term but also in the long run. How are you able to know whether the company is for the long term? 1 part of it is through the financial statements.
From financial statements; you able to know the state of the company's business and finance such as:
- How the company manages its cash?
- Whether their sales growing?
- Do they overproduced or underproduce their products?
- Are they able to cut costs?
- How much profit they make?
- How heavily in debt are they to run the company?
- How much is the amount of credit do their customers owe them?
- How much free cash flow do they have?
- If they pay dividends, are they paying in accordance with the profit they make?
All these points are more than enough to tell you how stable is the company. While the rest in the financial statement, you don't have to pay much attention to. But why?
There are two reasons I could give clearly:
The first reason is: If you were to know and read everything in the financial statements, that is like doing an accounting; and if accounting skill is that essential, I believe all accountants can do so great in stock investing and become millionaires. See the idea? To add on, if you were so caught up with the financial statement, I believe by the time, you already missed out on many stock opportunities (Peter Lynch stated that in his book too).
Second Reason: Investors really need to understand that what moves the stock is seldom due to the underlying businesses (most part of it) but rather the optimism and speculation of the market. And what drives the optimism and speculation are normally:
- the earnings of a company (Peter Lynch stated so).
- the individual who takes the lead in the company.
- the prospects of a company.
- people just like the stocks.
Take an example of Gamestop's stock (GME): The businesses are deteriorating and yet the stock keeps shooting up. Why? Because their fan base just loves the stock and since they love it so much, they're willing to fight against the hedge funds who shorted it.
Another example would be Tesla (TSLA): The company has yet to prove they're a profitable company but because of Elon Musk, the company's prospects and also people just love the stock, which drives Tesla's stock high.
To add on, based on my stock investing experiences; I encountered many profitable and sustainable companies but their stocks stay stagnant for years. Why? Because nobody likes the stock thus there's no volume at all.
So we as investors, have to play smart in which:
- Research only the important fundamentals so as to ensure the stability and health of the company for the long run.
- Learn basic technical skills so we can take advantage of the market speculation and optimism by buying before the majority of the market starts to board the ship. Or if you wish to sell because of the fundamentals deteriorating, then sell before the sellers start to sell (this statement I've already emphasized in Part 2 of my article).
Thus, from here, I dare to state that financial statements do matter but not 100%.