A Basic Income Statement or Statement of Income
Is an important aspect of annual stock reports!
The basic income statement, or profit and loss statement, or statement of company performance, is the best place to find out where the company's money is coming from and going to.
It is therefore an important source of information when value investing.
A basic income statement example can be found in all annual company reports.
You might find it useful to use one of these statements to follow the discussion on the key areas I mention below.
These statements can be found in annual reports that are located on company websites.
Income Statement Template
There are several key items I look for on a basic income statement that are important for value investors like me to be aware of.
The first is revenue growth or sales growth. A company that is not growing its revenue or sales will find it difficult to grow its net profit.
A minimum benchmark of 5% growth per year on revenue or sales over the last few years is my reasonable expectation.
The operating margin is a key statistic for industrial and service companies. It shows the underlying profitability of the business before the effects of financing and from new investments.
The bigger the operating margin the better the potential profitability. The trend of operating margin is particularly important and can give a good indication of the long-term viability of a given business.
Another test of net income is earnings per share (eps) growth. I focus on companies with an eps growth of a minimum of ten percent annually over a five-year period.
A good business that is increasing sales and revenue should be showing a profit. But if the company is not keeping the lid on expenses, profits will suffer.
The net profit margin is a measure of the percentage of profit that ends up on the bottom line for every dollar sold or earned.
Some industry sectors tend to have small profit margins and some have larger, so I look for companies that have above average (and hopefully growing) net profit margins for their sector.
A sign of trouble is if the net profit margin declines over several years.
This could indicate a number of possibilities including the company's inability to control expenses, greater competition or an increase in the cost of materials.
So net profit margin would be best seen as trending higher over a number of years and be holding up above the industry average in that time period.
Keeping an eye on the above key items in the basic income statement provides valuable information for value investing.
If you are like me, it can be confusing to try to remember how some of these key items are calculated. So I have purposely not mentioned how these key figures are derived.
When value investing, it is better to focus on the number, and the trend in the number, not on how they are calculated.
These numbers like profit margin, earnings per share growth etc don't have to be calculated by you. They are readily available from online broker websites. If they are not on your broker's site, get another broker!
I have made bold only the key items above so that you can focus on what key items to look for. Hop up and have another look. There are four of them. They are ...
- revenue or sales growth
- operating margin
- earnings per share growth and
- profit margin.
If I could only pick one, which one would it be? It would be profit margin, because as I see it, it incorporates the others.
While the income statement does provide important information for value investors, it does not give you the full picture.
One important thing that the income statement doesn't show is how the company is paying for any growth over time. To find that, you need to look at the cash flow statement. Worth a look?
Return from Basic Income Statement to Analyzing Financial Statements
Return to Value Investing Home Page