Balance sheet: taking the first steps

13 בינו׳ 2023

Today we are going to start learning about fundamental analysis of companies. In my opinion, this is the basic skill you should have when picking stocks to invest in.

Once again, the main principle of the strategy I follow is to pick outstanding companies and buy their stocks at a discounted price.

You may have noticed that first-class products are occasionally discounted in stores, but not for long, because such products are quickly swept off the shelves, and almost the next day the price is again without a discount. Exactly the same strategy is applicable to the stock market. Now, fundamental analysis is a method for picking outstanding companies (that is, companies with strong fundamentals).

How can we tell if a company has a strong foundation or not? There is only one way - by analyzing its financial statements. Every listed company has to disclose this information publicly on its website. In other words, we don't have to extract that information - it is publicly available. You can also find it on TradingView and see the data in dynamics.

What is the content of this information? The company publishes three reports: balance sheet, income statement and cash flow statement.

The balance sheet, like the order book, can be presented as an open book. The left side of the book lists the company's assets and their valuation in monetary terms, and the right side lists the company's liabilities and equity, and their valuation in monetary terms.

What are company assets? These are everything that belongs to the company: buildings, equipment, trademark, shares of other companies, cash in the cash register. In general, all tangible and intangible property of a company are assets.

What are liabilities and equity of a company? These are the sources of funds that gave rise to the assets. For example, if you bought a computer for $1000 with your savings, then the computer is an asset, and your own savings are equity. If a friend lent you $100, and you put the money in your pocket, the money in your pocket is an asset, and the debt to your friend is a liability. Based on these examples, you can make an imaginary balance sheet:



As you can see, the entry in the balance sheet is the name of the asset, liability or equity and their monetary value. Assets, liabilities and equity are inextricably linked, so the sum of assets is always equal to the sum of liabilities and equity.

If we were to write every asset in this way on the balance sheet of a large company, it would turn into an endless book of hundreds of pages. However, if we look at the balance sheets of huge corporations, they can fit on a single sheet of paper. This is due to the fact that over time invented to group the same type of balance sheet items. Let's look at how the company's balance sheet items are grouped:




Don't be frightened. Now we will try to digest this table with the help of an example we are already familiar with. Let's think back to our master cobbler, specifically to the period when he was just starting out.

Let's assume what exactly he had at that time: a garage, a table, a chair, a sewing machine, tools, a bag with leather and rubber, thread, a safe with money, a phone book with clients' contact information, a IOU from his friend, and oil company stocks.



I have now listed the assets of our master, or should I say, of his workshop. I should note that what is listed here is exactly what is directly related to his business. Even the money in the safe, the debt from his friend, and the oil company shares came about because of the existence of the business. Let's say the master's apartment or the bicycle he rides in the park are not assets, because they don't belong to the workshop. They belong to the master, but not to his business.

Let's categorize the workshop's assets into groups. There are two big groups: Current assets and Non-current assets.

How should you distinguish them? The general rule is this: Current assets are what a company's product is made of, and what can turn into money in the near future, so they can be called quick assets. Non-current assets are where and with what we create the product, and what can turn into money not so soon (so they can be called long-term assets).

So, here we go:
- A garage, a table, a chair are where we create a product, so a long-term (non-current) asset.
- A sewing machine, tools - this is what we use to create a product - a long-term (non-current) asset.
- A bag with leather and rubber and thread is what a product is made from - a quick (current) asset.
- A safe with money is already real money - a quick (current) asset.
- A phone book with customer numbers - it's hard to sell it to someone quickly, such assets are also called intangible assets and are placed in long-term (non-current) assets.
- IOU from a friend, i.e. a friend bought boots from a master, but can pay only after receiving his salary - a quick (current) asset.
- Shares of an oil company - let's assume that a customer once paid for the boots with them - a long-term (non-current) asset.



So, we've just categorized the master's assets into two groups: current assets (quick assets) and non-current assets (long-term assets). In the next post, we'll break down the components of these two large groups. See you then!