It’s time for a health check.
We’re just emerging from the half-year profit reporting season and no doubt some of the companies in which you’ve invested have done well, while others have disappointed.
But profits – or losses – aren’t the be all and end all of what to look for in investing or to judge just how well your company is performing.
A couple of months back we looked at two key measures to consider when you first decide to invest in a company. One was called the Price Earnings Ratio, which essentially tells you how expensive a stock is. And the other was the dividend yield, which gives you an idea of what kind of annual return you can expect on the shares you’ve bought.
Over the next few weeks, we’ll consider a couple of other very important measures that can give you an idea about how your company is being managed. In each case, this will involve having a peek at the company accounts – those endless pages of numbers mailed out each year (or these days on the company’s website) that generally make your eyes glaze over.
You don’t have to be an accountant or even be good at maths to read a balance sheet. There are a couple of quick and easy checks that will give you a whole new perspective on the health of a company.
The two main ones we'll investigate involve liquidity and solvency, both of which compare the amount of debt a company is carrying to its assets.
We’ll also look at the auditor’s statement in the accounts, the first page to which you should turn.
There is no set formula for what constitutes how much debt a company should be holding. Obviously, it ought to have enough earnings capacity to repay the loan, or at the very least the interest on the loan. But generally, in good times, companies tend to borrow more so they can supercharge their profits. In bad times, such as the era from which we are now just emerging, debt often is considered a dirty word and many corporations will focus on reducing debt or risk being punished by investors.
Clearly, profits are essential. But many a profitable company has encountered financial difficulties. Some of the biggest collapses in 2008 were stockmarket darlings just a year earlier that were reporting huge earnings results.