Importance of Financial Statement Analysis

It is really important that every investor understands the investment basics of how to analyze corporate financial statements.  You shouldn’t be investing in a stock if you don’t know how to read their underlying financials.  It’s really fundamental in understanding the stock market and how it works.

Financial statement analysis is the backbone of understanding how a company functions and how it performs.  The numbers tell the true story of what is really going on in a company.  If you don’t know how to read a company’s financial statement, then you really don’t understand how to evaluate a company and it’s stock.

For example, a fundamental way to invest in stocks is to do value investing.  This is a method that starts out with analyzing a company’s financial statements.  You look at their numbers and first determine how much that company is worth.  It may be worth $100 million, $1 billion or $2 billion.  Without understanding their financials, you can’t determine how much they are worth.

Next you look at their market cap, which is the measure of what the stock market thinks it is worth.  If you think the company is worth $1 billion and the stock market thinks it is worth $800 million, i.e. the market cap, then you have a winner.  But you can’t come to that conclusion if you don’t know what the numbers say in the beginning.

If your stock investment strategy does not look at how much a company is worth based on financial statement analysis, you are missing a big piece of the puzzle.  Even traders have a sense of how much a company is worth when they are trading them.

Understanding financial statements is a huge step to understanding stocks and the companies that are attached to them.  The numbers tell a story of how they are really doing, in spite of press releases, CEO speeches or analysts’ comments.

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