Course index:
- Basic Concepts of Money and Personal Finance
Introduction to the value of money, the importance of saving, and spending control. - Budgeting and Financial Planning
Create a personal budget, manage income and expenses, and set financial goals. - Inflation and Purchasing Power
Explanation of how inflation affects the value of money over time. - Interest Rates and Time in Finance
Differences between simple and compound interest rates and their importance in investments. - How to protect your savings. Protect yourself from scams.
How to protect your money from the scams that abound today - Basic Savings Instruments
Explanation of savings accounts, term deposits, and how they work. - Introduction to the Stock Market
Basic concepts of the stock market and its role in the global economy. - Actions: What They Are and How They Work
Explanation of stocks, types (common and preferred), and how to invest in them. - Bonds: What They Are and How They Work
Differences between corporate and government bonds, and their importance in diversification. - Risk vs. Return on Investments
Concept of risk and how it affects investment choices. - Diversification and Creation of Basic Portfolios
Basic diversification principles to reduce risk in an investment portfolio. - What is an ETF and How Does it Work?
Introduction to ETFs (exchange-traded funds) and how they track market indices. - What is a Mutual Fund?
An explanation of mutual funds and their benefits for beginners. - Financial education for the family
All the information you need to make ends meet. - Economic Cycle and its Impact on Investments
How the stages of expansion and contraction in the economy affect investments. - Growth Stocks vs. Value Stocks
Learn about different types of actions and what to expect from each one. - Fundamental Analysis of Stocks
Explanation of how to analyze a company's value based on its fundamentals. - Basic Technical Analysis: Charts and Patterns
Introduction to basic technical analysis tools, such as trend lines and candlestick patterns. - Options: What They Are and How They Work
Basic concepts of call and put options and their uses in investments. - Futures: What They Are and How They Work
Introduction to futures contracts and their application in investment and speculation. - Introduction to Cryptocurrencies
What is digital money, how it was created, and the characteristics of Bitcoin and other cryptocurrencies. - Blockchain and its Importance in Finance
How the technology behind cryptocurrencies works and their applications in finance. - Risks in Cryptocurrency Trading
Volatility, fraud, and regulations in the cryptocurrency market. - Leverage Principles and its Risk
What it means to trade with leverage and the associated risks. - Investor Psychology and Emotion Management
How emotions influence investment decisions and tips for managing them. - What is Algorithmic Trading
Basic explanation of the use of algorithms to perform operations in the financial market. - Financial Analysis of Companies
Introduction to basic financial statements and their interpretation for valuing companies. - Investing in Commodities: Gold, Oil, and Other Goods
How commodity investments work and their role in diversification. - Advanced Investment Strategies: Hedging and Derivatives
Introduction to strategies for managing risks through financial derivatives. - Creating and Managing a Complete Portfolio
Practical application of prior knowledge to build and manage a diversified portfolio.
Financial Analysis of Companies: A Complete Guide to Understanding the Numbers
Financial analysis of companies is like looking under the hood of a car: it shows you how it works inside and whether it's in good condition. It is the process of studying a company's numbers to determine if it is a good investment or if it is in trouble.In Argentina, where the economy is challenging and businesses face inflation, devaluation, and constant change, understanding this analysis gives you an advantage in making smart decisions.
This lesson will explain how to interpret financial statements (balance sheet, profit and loss, with a focus on operating, net, and gross profit), how to calculate financial ratios to evaluate profitability, and how to analyze cash flow. All delivered in a clear and relaxed tone, like a chat with a friend, as readers of The Pocket Investor series are accustomed to.
What is business financial analysis?
Financial analysis is like a medical checkup for companies. It consists of checking your numbers to see if they are healthy, growing or about to break.It's not just about looking at how much money they earn, but also understanding how they use it, what debts they have, and whether they can continue to move forward. In Argentina, with volatile markets like the Buenos Aires Stock Exchange (BYMA) and the dollar occasionally skyrocketing, this analysis is key for investors who want to protect their money.
The goal is to make informed decisionsIf you're an investor, it helps you choose where to invest your money. If you're an entrepreneur, it helps you see how your business is doing and how to improve it. Let's break it down step by step, starting with the financial statements, which are the foundation of everything.
Interpretation of financial statements: Balance sheet, profit and loss
Financial statements are like a company's health reports. They are documents that show your financial situation and how you fared during a period.The two main ones are the balance sheet and the profit and loss statement. Let's look at them in detail.
Balance Sheet
The balance sheet is a snapshot of the company at a specific point in time, such as December 31st. It shows what you have (assets), what you owe (liabilities), and what is left for the owners (equity).Imagine it's like going through your wallet: how much cash you have, how much you owe someone, and what you have left over.
- Assets: Everything the company owns, such as money in the bank, machinery, inventory, or buildings. For example, a company like YPF owns oil wells and trucks as assets.
- Liabilities: Debts, such as bank loans or outstanding bills. If YPF took out a loan to purchase equipment, that goes here.
- Heritage: What remains after subtracting liabilities from assets. It's like the company's net worth, what it would be worth if it were sold at book value. This is known as book value. A widely used ratio is Price/Book Value, which divides the company's listed price on the stock market by its book value. Logic would dictate that this value should be greater than 1, since a company is more than just a set of assets and liabilities: there are many intangibles, such as the relationships it has built with customers, suppliers, etc. This is often referred to as goodwill. But we'll leave it at that to avoid further complicating matters.
In Argentina, with inflation, balances are adjusted by pricesThis means that the values are not fixed, and you have to look at the footnotes to understand how they changed.
Profit and Loss Statement
This statement is like a summary of how the company did in a year. Shows income, expenses, and final profit (or loss)Important concepts such as gross profit, operating profit, and financial profit come into play here.
- Gross profit: It is what remains after subtracting the direct costs of producing something from revenue. For example, if a clothing company sells for 1 million pesos and it cost 600,000 pesos to manufacture, the gross profit is 400,000 pesosIt's a first look at whether the company is selling well.
- Operating profit: This is where operating expenses are included, that is, all the expenses the company needs to operate but that are not directly related to production. For example, a textile company typically has an HR team. They don't directly produce clothing, so they are considered operating expenses. All of these expenses are subtracted from gross profit. If you subtract 200,000 pesos in expenses from those 400,000 pesos, the operating profit is 200,000 pesosThis shows whether the company makes money from its core business.
- Financial gain: It is the result of profits or losses from interest, investments or debts. If the company pays 50,000 pesos in interest on a loan, but earns 30,000 pesos on investments, the net financial gain is -20,000 pesosIn Argentina, with high rates, this can be a headache.
- Net profit: It is the final result after adding or subtracting everything. If you subtract financial and other taxes from the operating profit, you have the net profit.. It's what the company really has left.
In Argentina, companies such as Mercado Libre, Banco Macro or Galicia publish these statements every quarter.They are required to do so as publicly traded companies and have a legal deadline to do so. Most local companies submit their quarterly financial statements in May, August, and November, and their annual financial statements in March.
Calculation of financial ratios to evaluate profitability
Financial ratios are like a thermometer to measure the health of a company. They are simple calculations that tell you if it is profitable, how it manages its money and if it can pay debts.Here I explain the most important ones to evaluate profitability:
1. Liquidity Index
- Definition: Measures a company's ability to pay its short-term debts with its liquid assets.
- Formula:
- Current Liquidity Ratio: Current Assets / Current Liabilities
- Quick Liquidity Ratio (or acid test): (Current Assets – Inventories) / Current Liabilities
- Interpretation:
- If it is greater than 1, the company has enough to cover its immediate debts.
- If it is less than 1, you may have liquidity problems.
- Example: If a company has $100,000 in current assets and $50,000 in current liabilities, its current ratio is 2, indicating good short-term health.
2. Solvency Index
- Definition: Evaluates a company's ability to meet its long-term debts, reflecting its financial stability.
- Formula:
- Debt/Equity Ratio: Total Debt/Net Worth
- Interest Coverage Ratio: EBIT (Earnings before interest and taxes) / Interest Expense
- Interpretation:
- A high debt-to-equity ratio (e.g., >2) indicates that the company relies heavily on debt, which can be risky.
- An interest coverage ratio greater than 1.5 or 2 shows that the company generates enough profit to pay interest.
- Example: If a company has $200,000 of debt and $100,000 of equity, its debt-to-equity ratio is 2.
3. P/E (Price-to-Earnings or Price/Earnings)
- Definition: Relates the price of a company's stock to its earnings per share, indicating whether it is "expensive" or "cheap."
- Formula: Share Price / Earnings Per Share (EPS)
- Interpretation:
- A high P/E (e.g., >20) may mean that the market expects high future growth or that the stock is overvalued.
- A low P/E (<15) could indicate undervaluation or problems in the company.
- Example: If a stock costs 1TP4Q50 and the EPS is 1TP4Q2, the P/E is 25, which suggests growth expectations.
4. P/B (Price-to-Book)
- Definition: Compares the market price of the company with its book value (assets less liabilities).
- Formula: Share Price / Book Value per Share
- Interpretation:
- P/B < 1: The company is undervalued relative to its net assets.
- P/B > 1: The market values the company above its book value (common in companies with strong intangibles, such as technology).
- Example: If a stock costs 1TP4Q30 and its book value per share is 1TP4Q20, the P/B is 1.5.
5. EBIT (Earnings Before Interest and Taxes)
- DefinitionEBIT stands for "Earnings Before Interest and Taxes." It's a measure of a company's operating profitability—that is, how much profit it generates from its core operations alone, without considering how it's financed (interest) or tax effects (taxes).
- Formula:
EBIT = Total Revenue – Operating Costs (excluding interest and taxes)
Or alternatively:
EBIT = Net Profit + Interest + Taxes - Why is it useful?:
- It allows you to compare operating profitability between companies regardless of their debt structure or the tax rates of the countries where they operate.
- It is an indicator of the efficiency of the core business, before financial costs.
- Example:
Suppose a company has:- Revenue: $1,000,000
- Operating costs (excluding interest and taxes): $700,000
- Interest: $50,000
- Taxes: $80,000
So:
EBIT = $1,000,000 – $700,000 = $300,000
Or also: Net Profit ($170,000) + Interest ($50,000) + Taxes ($80,000) = $300,000.
6. EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)
- DefinitionEBITDA stands for "Earnings Before Interest, Taxes, Depreciation, and Amortization." It's a broader version of EBIT, as it also excludes depreciation (loss of tangible assets like machinery) and amortization (loss of intangible assets like patents).
- Formula:
EBITDA = EBIT + Depreciation + Amortization
Or directly:
EBITDA = Total Revenue – Operating Costs (excluding interest, taxes, depreciation and amortization) - Why is it useful?:
- It is an approximation of operating cash flow, since it eliminates non-monetary items (depreciation and amortization).
- Widely used in industries with high expenditures on fixed assets (such as manufacturing) or intangible assets (such as technology), because it levels out differences in accounting policies.
- Popular in business valuation (e.g. with EV/EBITDA).
- Example:
Using the data above, we add:- Depreciation: $40,000
- Amortization: $10,000
So:
EBITDA = EBIT ($300,000) + Depreciation ($40,000) + Amortization ($10,000) = $350,000.
7. EV (Enterprise Value)
- DefinitionEV is a measure of a company's total value, considering not only its market value (market capitalization), but also its debt and available cash. It represents what it would cost to "buy" the entire company, assuming you take on its debt and keep its cash.
- Formula:
EV = Market Capitalization + Total Debt – Cash and Cash Equivalents- Market Capitalization = Share Price × Number of Shares Outstanding
- Why is it useful?:
- Unlike market capitalization alone, EV provides a more complete picture of value, including financial burden (debt).
- It is key in mergers and acquisitions, because it reflects the true cost of acquiring a company.
- It is often used with EBITDA (EV/EBITDA) to assess whether a company is expensive or cheap.
- Example:
Suppose:- Share price: $50
- Outstanding shares: 1,000,000 → Capitalization = $50 × 1,000,000 = $50,000,000
- Total Debt: $10,000,000
- Cash: $2,000,000
So:
EV = $50,000,000 + $10,000,000 – $2,000,000 = $58,000,000.
Relationship between EBIT, EBITDA and EV
- EBIT vs. EBITDA:
- EBIT includes the effects of depreciation and amortization, while EBITDA excludes them. Therefore, EBITDA is typically higher than EBIT and is considered a more "raw" measure of operating cash flow.
- Example of the previous case: EBIT = $300,000, EBITDA = $350,000.
- EV and EBITDA together (EV/EBITDA):
- This ratio measures how many times the total value of the company (EV) exceeds its capacity to generate operating profit (EBITDA).
- Example: If EV = 1TP4Q58,000,000 and EBITDA = 1TP4Q350,000, then EV/EBITDA = 165.7 (this would be unusual; in practice, real companies have lower ratios, such as 8-15, depending on the sector).
Other important ratios and definitions
- Net profit margin: It is the net profit divided by the revenue, multiplied by 100 to get a percentage. If a company earns 100,000 pesos with revenues of 1 million, the margin is 10%This tells you how efficient they are at making money. In Argentina, a margin of 5-10% is good for inflation.
- Return on Equity (ROE): It is the net profit divided by the equity, by 100. If you earn 100,000 pesos and your equity is 1 million, the ROE is 10%. It shows how much you earn with the owners' money. Companies like YPF often have variable ROE due to the fluctuations in oil prices.
- Return on assets (ROA): It is the net profit divided by the total assets, times 100. If you have 100,000 pesos in profit and 2 million in assets, the ROA is 5%. It indicates how the company uses its resources. In Argentina, a positive ROA is a good sign.
- Operating profit margin: Operating profit divided by revenue, by 100. If you earn 200,000 pesos operationally with 1 million in revenue, the margin is 20%This measures the efficiency of the core business.
- Market capitalization: This is the price at which all the shares of a publicly traded company would be purchased. It's calculated very easily by multiplying the number of shares outstanding by the trading price. For this reason, it doesn't tell us much about the individual value of a share, since the number of shares varies constantly and can differ significantly between companies.
These ratios are easy to calculate with the financial statementsIn general, it's always best to compare these ratios with similar companies to see if they're in good shape. For example, an ROE of 151TP3Q on Mercado Libre may be normal, but low for a more stable company.
Cash flow analysis
Cash flow is like the pulse of a company: it tells you if it has money to operate. It's the money that comes in and out, not just paper profits.Profits may be high, but if there's no cash, the company could go bankrupt. Let's see.
- Operating cash flow: It is the money generated by the daily business. You subtract operating expenses from revenue and adjust for things like debt or inventory.If a company like Galicia earns 500,000 pesos but pays 300,000 in salaries, the operating cash flow is 200,000 pesos. This shows whether the business is sustainable.
- Investment cash flow: It is the money used to buy or sell assets. If YPF invests 100,000 pesos in a new well, this comes out of the investment flowA negative flow here is not bad if it is for growth.
- Financial cash flow: It is the money from debts or payments to owners. If a company pays 50,000 pesos in interest or 20,000 in dividends, this affects the financial flowIn Argentina, with high rates, this flow is often a challenge.
Net cash flow is the sum of the threeIf it's positive, the company has extra cash; if it's negative, it could be in trouble. In Argentina, with inflation, cash flow is key to knowing whether a company can survive without borrowing.
How to use financial analysis in Argentina
In Argentina, financial analysis has its tricks. Inflation distorts the numbers, so values must be adjusted for prices. For example, a 2023 balance sheet in current pesos doesn't reflect reality unless you correct it for inflation. The CNV requires companies to publish adjusted statements, but you still need to read the notes.
Compare with the sectorIf you analyze YPF, look at other oil companies like Vista Energy. If YPF's ROE is 81TP3Q and Vista's is 121TP3Q, it could be that YPF isn't performing well. In Argentina, where everything changes, this gives you context.
Practical examples
Let's imagine Juan, an investor from Rosario. Analyze Mercado Libre's balance sheet and see that it has 1 million in assets, 400,000 in liabilities, and a net profit of 150,000 pesos.. He calculates an ROE of 25% (150,000 / 600,000 x 100), which is good. He decides to invest because the company is growing.
But María, from Mendoza, looks at a small company. The operating cash flow is negative (-50,000 pesos) because it spends more than it earns.. You decide not to invest, and months later the company goes bankrupt. These examples show how analysis saves.
Advantages of financial analysis
- Informed decisions: You know where you put your money.
- You identify risks: You see debts or weak cash flows before it's too late.
- You take advantage of opportunities: You find undervalued companies.
Risks and limitations
- Manipulated data: Some companies may falsify their numbers.
- Inflation: In Argentina, adjustments are not always precise.
- Changing context: A healthy company today can go bankrupt tomorrow.
Tips for analysis
- Use recent data: Check out the latest statuses.
- Learn how to adjust for inflation: It is key in Argentina.
- Consult experts: An accountant or advisor guides you.
Financial analysis is your compass in a crazy marketIn Argentina, with practice, you can use it to invest wisely.
Next course date
Questions for you to reflect on
Why is it worth taking the time and effort to understand balance sheets?
Why isn't knowing a company's P/E enough?
Why is a company's growth a key factor when analyzing ratios? What problem does this present?
A brief overview of The Pocket Investor
The Pocket Investor is a project that combines experience and passion for financial education to help you transform your relationship with money. Through personalized mentoringWe help you design investment strategies tailored to your goals and needs, optimizing your portfolio to address challenges like inflation and the dollar.
The books on finance and investment, including the popular The Argentine Pocket Investor - El Inversor de Bolsillo argentino, are practical tools that explain complex concepts in a simple way, bringing the world of investments closer to anyone interested in financial growth.
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