A great company needs a great business model (which we covered in the last chapter 'The 1st step in value investing is 'Picking Great Companies.') plus great operating performance to get great results.
So, we have to read their financial statements to see if that performance is actually any good. Think of it this way: You wouldn't buy a new phone or appliance without reading the 'spec sheet,' right? If you're going to buy a company's stock, you have to know exactly what you're getting into.
What is Financial Statement?
They are a systematic summary of a company's financial data, prepared over a specific period according to standard accounting principles.
They include the 'Big Three' statements that value investors must know: the Balance Sheet, the Income Statement, and the Cash Flow Statement.
These reports help stakeholders (like us!) assess the company's health, determine its value, and make informed decisions. Being able to read them is a fundamental skill for any value investor.
The Difference Between Quarterly and Annual Reports
Both quarterly and annual reports are official documents that record a company's performance. Besides the 'Big Three' statements we just mentioned, they also include details on business operations, organizational structure, and more.
Quarterly vs. Annual ReportsWhy Read Financial Statements?
Before the earnings report drops (or: comes out), the most investors have to go on is maybe the top-line revenue. Other than that, they're just guessing based on media hype and what other investors are saying.
But after the report is released, we finally get the real story.
This is one of the very few chances where the 'average retail investor' gets to be on a 'level playing field' with the big institutions.
When are Earnings released?
When a company releases its earnings, it's basically like handing in a 'report card' to investors.
It provides them with critical insights into the company's financial health, operating performance, and future potential. For value investors, this information is the crucial foundation for making their decisions.
For value investors, earnings reports are a major event every quarter and every year.
It's their chance to confirm if the company is heading in the right direction (or the wrong one), and to see if their original 'investment thesis' still holds up.
The exact release date varies by company, but they all must meet their official filing deadlines.
US Earnings Report Timing
Officially, quarterly reports (10-Qs) are due within 40 to 45 days after quarter-end, and annual reports (10-Ks) are due within 60 to 90 days after the fiscal year-end.
In practice, however, most major US companies report their earnings during the second week after the quarter closes.
That's why the second weeks of January, April, July, and October (which follow the end of each calendar quarter) are famously known as 'Super Week' or the peak of 'Earnings Season.'
💡 Not every company's 'Fiscal Year' is the same as the 'Calendar Year' which is January 1 to December 31.
💡 Get your information (or: Get the data) 'straight from the source': The U.S. Securities and Exchange Commission (SEC) at https://www.sec.gov .
US Earnings Release ScheduleTaiwan Earnings Report Timing
Quarterly reports are due within 45 days after the quarter-end, and annual reports are due within 75 days after the fiscal year-end.
The annual report deadline, specifically, used to be 90 days, but this was adjusted to 75 days starting in 2023.
💡 Get your information (or: data) 'straight from the source'—Taiwan's 'Market Observation Post System' (MOPS) at https://mops.twse.com.tw .
Taiwan Earnings Release ScheduleThe 'Big Three' Statements
This refers to the Balance Sheet, the Income Statement, and the Cash Flow Statement. These reports show a company's financial structure and its operating profits. They are how you objectively 'grade' a business's performance.
To put it simply, they tell you: how much 'stuff' (assets) a company has, how much profit it's making, and how much actual cash it's bringing in.
- Balance Sheet: How many assets the company currently owns.
- Income Statement: How much profit the company is generating each year.
- Cash Flow: How much actual cash the company is bringing in.
Balance Sheet
Assets = Liabilities + Shareholder's Equity
This statement records a company's assets and financial position at a specific point in time.
From an accounting and legal view, it shows how the company financed those assets—either through debt or through owner's/shareholder's equity—which helps you judge the health of its capital structure.
Income Statement
The Income Statement records a company's profitability over a period of time—usually a quarter or a year.
It shows how a business generates profit from selling goods or providing services by calculating its revenues, costs, and expenses.
Cash Flow
The Cash Flow Statement tracks a company's cash inflows and outflows over a period. It helps investors see if cash is actually coming in the door and where it's all going.
You might be wondering: 'But doesn't the Income Statement already tell us if they're making money?
Here’s the key: The Income Statement shows 'on-paper' performance, which can hide certain traps.
Cash is the real money that actually makes it into the company's pocket. This is exactly why Buffett loves this statement; it cuts through the accounting 'noise' and shows the real cash.
Analysis and Judgment
Analysis' isn't just about 'crunching the numbers.' It's about looking at the situation from multiple angles to make an objective judgment.
This means converting raw data into ratios, spotting trends over time, and benchmarking against competitors.
And on top of all that, you have to look beyond the numbers and also factor in the macro-economic environment and overall industry dynamics.
Numbers and Trends
By using a standard SOP—which includes ratio analysis, trend analysis, and horizontal comparison—investors can get a much deeper understanding of where the company currently stands.
1. Ratio Analysis
Financial statements need a lot of 'line items' to clearly reflect a company's operations. Add in comparisons to prior years or quarters, and the whole report is just flooded with numbers.
If you just look at the the raw data', it's hard to tell if something is actually good or bad.
That's why value investors convert these raw numbers into ratios. It helps them make sense of the situation much more easily.
For example, look at the two items below. The raw number has a ton of digits and is hard to digest at a glance. But once you convert it into a ratio, you get the picture immediately.
Ratio Analysis Example2. Trend Analysis
You have to look at financial data over multiple consecutive periods—not just one. A single ratio in on its own can't tell you if the company is getting better or worse.
You have to lay out the numbers over several years or quarters in a row to truly see the 'big picture'.
For example, 10% revenue growth might look decent at first glance. But what if the trend over the last few years was 22%, then 18%, and now 10%? That clearly shows a decelerating growth trend.
Or, an EPS of $0.10 might not seem like much. But if the trend was -$1.30, then -$0.40, and now $0.10, it shows the company is making a turnaround.
Trend Example3. Peer Comparison
This means lining up companies from the same industry and comparing their financial data or ratios head-to-head.
It helps you gauge their relative performance and get a true sense of their market standing and competitiveness.
Sometimes, a company's trend viewed in isolation can be misleading. Seeing it next to a competitor can completely change your initial assessment.
For example, Company A's revenue growth goes from 22%... to 18%... to 10%. Your first instinct is to see this slowdown as a negative.
But then you look at a competitor, Company B, whose growth went from 23%... to 6%... to -1%.
This suggests the entire industry might be facing serious 'headwinds.' After this comparison, you realize Company A is actually 'holding up' much better.
Would you still judge their 10% growth so negatively?
Peer Comparison ExampleAssessing the Economic Environment and Industry Dynamics
When value investors analyze a company, they can't just 'crunch the numbers.' They must also factor in the overall economic environment and industry dynamics. The situation is constantly evolving and could flip your entire analysis on its head. It's precisely because there are so many facets to consider that everyone's conclusion will be different. This is a core part of the 'wisdom' that value investors must learn.
Assessing the macro and industry dynamics isn't like running the numbers—there's no simple SOP you can follow. It relies entirely on your personal acuity for how the environment is changing.
Let's revisit our last example: Company A's growth (22%...18%...10%) looked better than Company B's (23%...6%...-1%). But what if both companies are legacy desktop PC makers? And they're being disrupted by the smartphone boom? This is a massive structural change.
In this new context, Company A's 10% growth doesn't mean it's 'competitive'—it just means it's on a slower path to irrelevance. This entire analysis is invalid unless Company A is aware of this and actively 'pivoting'. And if it is, you then have to analyze the likelihood of that pivot succeeding and the timeline involved.
Understanding the Actual State of the Business
Value investors must 'know the business inside and out.' Reading financial statements is how you grasp the company's actual, real-world performance. Are they profitable? How profitable? Do they have debt? How much debt? The numbers tell you the story. This data helps you make rational, informed decisions and avoid blind speculation.