Investment Tips
07/10/2020
Analysing Companies – Financial Statements
Ray Calleja

An article written by Ray Calleja: Head – Private Clients, MeDirect



Having discussed many aspects and concepts of investing in mutual funds in previous articles, we will now start discussing a new topic on how to analyse the underlying performance of companies. We would like to think ourselves as investors rather than speculators, which would be the case if we make uninformed decisions when we decide to purchase shares or bonds of a company that we like or fancy. This subject should be of interest to those investors who would like to discover more about how to evaluate a company’s performance.

Principal Types of Analysis

A good assessment of a company entails two types of analysis – a Quantitative (also referred as “Fundamental Analysis”) analysis and a Qualitative Analysis.

Quantitative data will assist our examination of the company’s current financial status and its current and past performance. This will provide us with a suitable benchmark to estimate and predict a company’s future performance. The historical data provides essential pointers for such forecasts. For example, the level of debt relative to the amount of equity capital (referred to as “gearing” or “leverage”) in the business provides an indication as to the company’s capacity to be able to repay its debts on time. Also, the analysis of past cash flows may give us an indication on how future revenues can be generated, say in plant and machinery rather than being available for distribution to shareholders. A substantial part of such quantitative information, can be extracted out of a company’s audited Financial Statements which incorporate a balance sheet, a profit and loss account (also referred to as an “Net Income Statement”), an Equity Statement, a Cash Flow Statement and Notes to the Accounts.

Whilst carrying out a Quantitative Analysis is very important, it may not, however, necessarily be sufficient. For a company to succeed well, solid qualitative attributes must exist. These come in various forms, including:

  • The nature of the industry where the company is operating
  • The competitive strength of the company within its industry
  • The competence, good self-governance and integrity of the management team

In future articles, we will take a look at how to perform the respective quantitative and qualitative analysis, but we shall begin by exploring ways to access such financial data as a basis to carry out a quantitative analysis.

Financial Statements

Reading a set of Financial Statements is not something that is terribly exciting but the ability to understand them is deemed to be rather essential for any investor, as they provide the principal source of quantitative information. The key elements of accounting are straightforward and you do not have to necessarily digest complex accounting principles to be able to understand the profit performance of a business or the value of the company’s assets. We, as investors, should try to gain confidence in being able to interpret the essential financial data.  The financial statements must follow accounting guidelines by the regulators but there is still room for subjectivity by the company’s directors and their accountants. Nevertheless, the Annual Report and Financial Statements provide plenty of useful information.

EU listed companies, whose securities are traded on a regulated market, must prepare their consolidated Financial Statements in accordance with a single set of International Financial Reporting Standards (IFRSs). IFRSs provide a common accounting language adopted by more than 100 countries and, thus, allow company accounts to follow comparable accounting techniques, across international boundaries. At international level, the EU supports the principle of a common set of worldwide accounting standards for listed companies and works with competent authorities, all over the world, to promote the adoption of IFRS. As some of the EU’s key trading partners have not yet adopted IFRSs (such as the U.S. where US General Accepted Accounting Principles “US GAAP” are applied), for certain non-EU countries, the functional accounting standards are recognised under equivalent high standards so as to facilitate cross-border listing, and thus enabling such foreign companies to be listed on EU markets.  Financial Statements are usually prepared to cover annual or half-yearly reporting periods.

Reporting Requirements for Listed Companies

Companies quoted on stock exchanges around the world present crucial fundamental data. Getting hold of a company’s Annual Report that include its Financial Statements is relatively very simple, these days. For example, all companies listed on the Malta Stock Exchange (MSE) have their annual reports available via the Malta Financial Services Authority’s (MFSA) website. Companies also provide such financial reports on their own website, many of them in the ‘About Us’ or ‘Investor Relations’ sections, for example, MeDirect Bank (Malta) plc. It is not unusual for companies to provide summarised / abridged versions of their Financial Statements alongside the respective full version. However, the former rarely contain sufficient information for someone who is trying to assess the company, and so using the full version is often necessary. Websites provide not only the most recent reports but also past reports, which can go back several years.

Similarly, for overseas companies such as the U.K. and the U.S., Annual Reports and Financial Statements are accessible on the companies’ own websites. Where companies are listed on the London Stock Exchange, as an investor you are advised to contact the relevant companies to obtain their Annual Reports, but it is also possible to obtain reports and accounts from Companies House for all companies, whether listed or not. Some websites provide market data information including financial information against a paid subscription.

In the U.S. it is, perhaps, easier to find Annual Reports, as the U.S. Securities and Exchange Commission (the “SEC”) stipulates that all companies, foreign and domestic, are required to file registration statements, periodic reports, and other forms electronically through its database called EDGAR. Anyone can access and download this information for free through its website. The various documents filed at the SEC have a reference number and the annual report is specifically known as the 10-K Report, which must be filed annually by every publicly-traded company and is a comprehensive report about its financial performance, with audited Financial Statements. For those not familiar with the U.S., the SEC’s mission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. Apart from the Form 10-K there are also the company's quarterly reports on Form 10-Q, and periodic reports of significant events on Form 8K.

Official listing of public companies in Malta is regulated under the Financial Markets Act (2002), which was amended in 2007 to take into account EU reforms. The administration of the Act falls within the remit of the MFSA, which is an official and independent body, also responsible for issuing Listing Rules. To be eligible to list equity securities on the MSE, the applicant must be an incorporated company, with its Memorandum and Articles of Association in conformity with the Listing Rules. This implies that securities must be duly authorised, in accordance with the applicant’s place of incorporation.

As per the MFSA’s Listing Rules, Appendix 5.2 named ‘Articles of Association’ the annual Financial Statements of a publicly-listed company, together with the directors’ and the auditor’s reports must be sent to the shareholders at least fourteen days before the company’s general meeting.

The Annual Report will contain the following:

  1. A director’s report
  2. A business review
  3. An income statement (profit and loss account)
  4. A balance sheet
  5. Equity statement
  6. Cash flow statement
  7. Remuneration statement or report
  8. Statement of responsibility
  9. Statement of compliance with the Principles of good corporate governance
  10. An auditor’s report
  11. Notes to the accounts

Companies must prepare an Annual Return, which is a  comprehensive document that contains information of a company relating to its share capital, indebtedness, directors, shareholders, changes in directorships, corporate governance disclosures, etc. in the prescribed format and filed annually, on the anniversary of company’s registration,  with the Registrar of Companies, within 42 days.

Companies are also required to file a signed copy of their annual Financial Statements. These must be accompanied by a copy of the relative auditors' report, as well as a directors' report. For a private company the annual accounts must be approved within 10 months from the year-end and submitted 42 days after the elapse of 10 months, whereas for a listed public company they must be approved within seven months and submitted 42 days from the financial year-end.

As per the same Listing Rules, section 5.74 the issuer of shares or debt securities shall make public a half-yearly financial report covering the first six months of each financial year. These may or may not be audited. However, the accompanying company announcement must make this clear. The half-yearly financial report shall be made available to the public as soon as it has been approved by the directors. This report shall be approved and made available to the public as soon as possible, after the end of the relevant period, but not later than two months after the elapse of the six months.

Companies must appoint, or re-appoint, external auditors at each annual general meeting to hold office until the next general meeting. The first auditors of the company are usually appointed by the directors, but thereafter the auditors are appointed by the company during the general meeting. 

Some publicly listed companies may decide to publish preliminary annual results for the year in an abridged / condensed format. These appear a few weeks after the financial year-end and provide shareholders with key data, such as profits and any important decisions, such as whether to pay a dividend on equity securities.

Companies’ Annual Reports also contain qualitative information such as the Chairperson and the Chief Executive Statements, the Directors’ Reports, etc. Since 2003, the European Commission has been active in developing action plans, recommendations, and directives related to corporate governance. As from 2006, the European Commission Directive 2006/46/EC requires all listed companies to publish a corporate governance statement in their Annual Reports to shareholders. This and other EU corporate governance reforms have succeeded in bringing about substantial convergence in corporate governance regimes among its member states.

The Listing Rules also impose an obligation on listed companies to issue certain company announcements in compliance with the ongoing listing obligations. The purpose of the announcements is to provide the market with useful and relevant facts in relation to the company that may potentially impact the quoted price of the related listed shares.

Subsequent Articles

In the next article we will start going through the main contents of the Financial Statements with brief outlines about the Profit and Loss Account; the Balance Sheet; the Cashflow Statements; the Chairperson’s and the Chief Executive Officer’s Review; the Directors’ Report; the Auditors’ Report; the Statement of Responsibility and Statement of compliance with the principles of good corporate governance.

 


The above is for informative purposes only and should not be construed as an offer to sell or solicitation of an offer to subscribe for or purchase any investment. The information provided is subject to change without notice and does not constitute investment advice. MeDirect Bank (Malta) plc has based this document on information obtained from sources it believes to be reliable but which have not been independently verified and therefore does not provide any guarantees, representations or warranties. MeDirect Bank (Malta) plc, company registration number C34125, is licensed by the Malta Financial Services Authority under the Banking Act (Cap. 371) and the Investment Services Act (Cap. 370).

The financial instruments discussed may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in any of the products discussed you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

 

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