Evaluating the Financial Performance of a Stock

When it comes to investing in the stock market, it’s important to always make sure that you are buying the right stock at the right price to make money. While there are a lot of different perspectives to look into for picking the right stock, the reality is the ultimate foundation behind a stock’s price is its fundamental analysis, or in other words its financial performance. Understanding this financial performance is critical in the long term towards picking a successful stock.

In order to evaluate the financial performance of a stock, the investor has to look at numerous criteria on the companies quarterly reports as well as some of the day-to-day adjusted metrics based on the movement of the stock price. There is also something to be said for technical analysis that tracks short-term price movements and signals opportunities to buy and sell to capitalize on better returns and preserve value in a downturn and enhance returns in an upswing.

The primary financial assessment tools for evaluating a stock are quarterly revenue and earnings. These are commonly referred to as top line and bottom line numbers on a companies income statement and indicate how inline their actual numbers are based on guidance given and analyst’s projections. These numbers not only impact the stock price, but help both the company and investors assess the current state of the companies financial position and business model, and how that will translate into future performance.

Beating these numbers are not the only checkmarks towards checking a companies finances, but are definitely the most important. Usually, if company insiders anticipate a huge miss or huge beat on these numbers, they tend to try to trade ahead of earnings reports. This has frequently happened with AMZN insider trading prior to Amazon releasing earnings reports.

While earnings misses are not always bad, especially in growth stocks, missing on revenue is usually a bigger red flag for companies. A miss on earnings may signal temporary concerns such as a company taking on additional debt, macroeconomic conditions that impact the cost of doing business, or a reallocation of revenue towards other parts of the business that would take away from the bottom line.

Revenue, however, is much more significant because it is the lifeline of a companies survival. If it can’t make money, that’s usually the first sign it is going to fail. While revenue estimates are provided on a quarterly basis, most analysts will value year over year instead of consecutive quarters. Similar to earnings misses, there may external circumstances that justify a temporary setback in quarterly revenues, but ultimately, investors want to see that over a sustained period of time, the revenues of the company are growing.

For companies that have sustained profitability, many investors want to measure the general health of that profitability. To assess this, many investors will look at the intrinsic value of a company’s free cash flow to gain insight into how efficiently a company operates. This is a measure of taking a strong portion of the companies bottom line and subtracting things such as capital expenditures to assess how much of a companies income is truly going to shareholders’ equity.

Outside of quarterly reports, it is up to an investor to make a determination if a company is a buy, hold, or sell on a day-to-day basis. When they do this, they ultimately look at the price-to-earnings ratio, in how companies real-time stock price trades in relation to recent earnings per share, usually based on the past full-year, or projected earnings for the next year.

The multiple of a stock’s price to its true earnings is indicative of revenue assumptions priced in already to a company name. Depending on the bullish or bearish investor, they may think that more assumptions could be priced in down the line or too many assumptions have been priced in whether by speculation or price manipulation and needs to come down.

The financial performance of stock must always be closely monitored so that investors know whether their underlying thesis is still intact or has already been met. Its important as an investor to always keep up with the news on a company so that you know what your investing in will garnish the returns you expect it to make.

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