Financial analysis is an essential tool in the work of determining the value of a company. However, financial analysis is not an easy task. The hard part of learning financial analysis is what if the financial statements are faulty? What if a listed company deliberately uses loopholes in accounting standards to mislead investors? What if a listed company deliberately falsifies its financials? Throughout history, there have been many cases where the financial statements look good but the company has actually gone wrong.
How should investors analyze financial statements to get the truth about a company?
1、Find the cockroach method
Regarding the "spot the cockroach" method, Warren Buffett once said, "First, be wary of public companies that publish less than solid financial data. For example, if a company doesn't expense stock options, or if its accounting for pensions is too generous, and so on, you need to be careful."
If corporate management is taking a worse approach to handling in certain areas where it can be seen, they will certainly do the same thing, or even go further, in areas where they can't be seen. It's like, when you see a cockroach in your kitchen, there's a good chance there's more than one in your kitchen.
In this "cockroach spotting" method, Warren Buffett points out a crucial way to understand financial statements. If there are problems in the statements, such as incomplete depreciation, inflated goodwill, or overcapitalization of R&D expenses, there is a good chance that there is more than a little problem. Since there is darkness under the sun, it can only get worse where there is no sunlight.
2, the root of the problem method
Warren Buffett's second method of spotting financial traps is called the "root-and-branch method. The original article reads:
"Ambiguous and unpredictable notes to financial statements often mean that the company's management cannot be trusted. If you can't understand a note in a financial statement, or if you can't understand some of the statements made by management (at your own level), it's often because management doesn't want you to understand them at all. For example, the description of certain transactions at Enron (a famous financial fraud company in U.S. history) has always bothered me."
In this approach, Buffett points out that investors need to get to the bottom of important issues in the statements. If there are obvious things in a public company's statements that they can't figure out, and they can't be reasonably explained, then they are often significant.
3、Watch out for self-aggrandizement
The third way to identify financial pitfalls, as Warren Buffett calls it, is to be wary of self-aggrandizement. If the management of a publicly traded company frequently predicts and boasts about its performance, the "too good to be true" scenario is often really not true.
Warren Buffett notes: "Be wary of companies that frequently make expectations and boast about their performance and growth. Business operations are often fraught with variables, and corporate earnings are often difficult to grow smoothly (except for those figures made up by investment banks). Not only do Charlie Munger and I not know how much money our companies will make next year, we don't even know how much money we will make next quarter."
"We are therefore skeptical of CEOs who claim to be able to predict the profitability of their businesses, and we would be especially skeptical if they then always met their predictions. Corporate management that always guarantees their future business performance and always achieves it must often end up needing to falsify their projections."
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