How to Read a Company's Financials Before You Invest

Why this matters more for direct stock investing

If you invest through mutual funds, a fund manager does this analysis for you. If you're picking individual stocks yourself (see our article comparing mutual funds and direct stocks), being able to read the underlying business's own numbers - not just its share price chart - is the difference between investing and guessing.

The three statements, in one line each

• Balance Sheet - what the company owns and owes, at a single point in time - a snapshot.
• Income Statement (P&L) - how much the company earned and spent over a period - a video, not a photo.
• Cash Flow Statement - how much actual cash moved in and out - because a profitable company on paper can still run short of real cash.

Each entry above goes into more depth on its own.

The ratios worth knowing first

• P/E Ratio - how expensive a stock is relative to its earnings - see our dedicated entry.
• ROE and ROCE - how efficiently a company uses shareholder money and total capital to generate profit.
• EBITDA - a company's core operating profit before certain non-cash and financing costs are subtracted.

A word of caution

No single number tells the whole story, and comparing ratios only makes sense within the same industry - a software company and a steel manufacturer have naturally very different "normal" ranges for most of these ratios, given how differently their businesses actually operate.

The takeaway

These statements and ratios won't tell you where a stock's price is headed next week, but they will tell you whether the underlying business is genuinely healthy, growing, and capable of paying back the confidence you're placing in it by buying its shares.