LazyFA is fast approaching 10,000 users. As I spend a large majority of my time on the site developing features, testing code and fixing bugs, I often wonder how users are actually using the site, which features they're finding most helpful, and which ones need improvement. To that point I recently reached out to an avid LazyFA user and asked him to share with me what his analysis process is like when investigating a new opportunity. He wrote up an excellent two part article explaining the basics of how he delves into the financials, using LazyFA to compare the company's recent performance against its past performance as well as to compare the company itself against its competition. This is part one (stay tuned for part two in a couple days!)
“An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”
- Benjamin Graham, The Intelligent Investor
In a society fueled by instant gratification, one must be cautious when dealing with the stock market. Many so called investors blindly enter the machine known as Wall St. with zero strategy or game-plan. They simply throw money at a commission free broker with fancy charts and promises of “good plays.” I was one of those “investors.” I use quotes around the word because what I, like many others, was doing cannot be considered investing. It was more like gambling. Investing, in my own words, is knowing as much about a company and how they operate as possible, before you even consider pressing the trade button. A stock may be the next big thing with promises of fortune and tripling equity, but be cautious. Investing is much more than just going through a company’s financial reports with a fine tooth comb, but this article is going to focus on doing just that.
For today’s example we will be using a defense sector stock; General Dynamics (GD). General Dynamics Corporation operates as an aerospace and defense company worldwide. It operates in five segments: Aerospace, Combat Systems, Information Technology, Mission Systems, and Marine Systems. Their market cap at the time of writing was $53.302B.
Now that we have our company established we are going to dive into their financial statements. I am not going to go into detail on what a fundamental analysis strategy is; that would make for a very long article. According to Investopedia:
Fundamental analysis (FA) is a method of measuring a security’s intrinsic value by examining related economic and financial factors. Fundamental analysts study everything that can affect the security's value, from macroeconomic factors such as the state of the economy and industry conditions to microeconomic factors like the effectiveness of the company's management.
Let’s begin! The very first step I take when looking into a company is taking a quick look at LazyFA’s red flag analysis tool. This gives me a very broad overview of each financial statement. I highly recommend this tool if you are just starting out as it takes specific metrics of financial statements and either marks them as green or, as the tool suggests, red. Obviously we would like to see more green than red.
The red flag analysis tool has done its job. It has given us a bird’s eye view of the income statement, cash flow statement, balance sheet, and cross statement. Our balance sheet looks a little red so we’re going to dig deeper and see why these flags were triggered by the website. To do this, click “Learn More” next to the balance sheet tab. Scroll to the “Red Flags” section at the bottom of that page.
Clicking each one of these flags will give an explanation of what it represents and why it was triggered. This is one of my favorite features about the website. It is simple enough to just look at the amount of red on the screen to make a judgment if a stock is worth picking up, but being able to see why the tool flagged them is important. Let’s see why “Overweight Intangible Assets” was triggered.
The next section of the site we are going to navigate to is the ChartMachine. This powerful tool will allow us to chart different metrics from General Dynamic’s latest SEC filings. By doing this we can see how the company is performing over time, fundamentally. The first plots on the chart are simple: Revenue and Cost of Revenue:
Look at that, General Dynamics is making a profit here. At a high level, revenue shows us what the company made during a specified quarter and the cost of revenue shows us how much money was spent by the company to, well, make money.
Now I want to take a pause here. Different companies in different sectors will have a wide array of fundamentals. A company that is seasonal may trigger lots of red flags and show strange lines on the chart. This is normal. As an investor it is your job to understand how your company, yes your company, is structured and what time of year they make product and sell product. Gold miners, for example, put a lot of their free cash flow back into the ground, literally. They buy more equipment, they hire more workers, it’s just the nature of business. This would trigger a red flag, no doubt, so you must understand that there are exceptions to every rule.
We are going to now plot two very specific metrics: accounts receivable and inventory. These two metrics are, to me, extremely important. With the exception of seasonal companies that build up inventory before a certain time of year, a company that is loading up on inventory while simultaneously having a down trend in sales is a huge red flag. In fact, Charles V. Payne wrote an entire section in his book “Be Smart, Act Fast, Get Rich: Your Game Plan for Getting It Right in the Stock Market” about inventories that rise faster than accounts receivable over time.
Once again we see good things here. Being a defense sector giant, General Dynamics won’t have as much inventory as say a company like Apple however, the metric still applies and we can see they are invoicing more customers at nearly double the rate they are adding to their inventory. Ideally we want to see this trend continue on top of many other ratios and metrics.
This concludes part one of this dive into how I determine if a company's management can “see past a quarter” and truly lead shareholders to success. In part two we will start comparing other companies inside the chart machine tool and getting a better idea of just how powerful LazyFA is. Stay tuned!