How to choose for investing in company shares for long term using financial statements to reduce mistakes?
Warren Buffett says real investment in share market is investing for long term. Stock market investing should be considered as acquiring a part of the business but not buying and selling on speculations.It is amenable to a lot of mistakes.
When we invest in share market, we should select companies that are simple and sustaining while making substantial profits even under pressure from competitors and also in adverse economic conditions. These features are available to us after analyzing financial statements over past several years. This attitude on investing reduces the risk of share market investing into a greater level.
On the other hand, risk of investing is fairly high on speculative investing. Speculation is really an excise of gambling. Price fluctuations in the share market are not following any basis but purely follow the mass mentality to rumors.
The most of factual evidences are available in financial statements. Therefore, You collect past financial statements from the Internet, which is free, and learn to analyze them.
Financial statement consists of income statement, Balance sheet and cash flow statement. Income statement shows a lot of evidences of the business strengths of the company.
We have to safeguard our principal and then make profits for correct and safe investments. Investing is not risky but not investing is risky.
Evidence from income statement
Business with 40% or more ‘gross profit margin’, which is consistent over last 7-10 years is safe to mark as a business with a durable competitive advantage. ‘Gross profit margin’ is calculated by dividing gross profit from total revenue.
Still operating expenses can adversely reduce benefits of high profit margin. One is expenditure on loans. Loan expenditure of a consumables producing company should be less than 15% of the operating income to be in a long-term competitive advantage.Successful businesses with durable competitive advantage earn money for leverage by themselves. Second, selling and administrative cost for such as payrolls, advertising, commissions, should be limited to 30% to 80% of operating income. Finally, researches cost to compete with the same category of businesses are also considered. According to Warren Buffett, Basically, secret of making money is spending less to earn more money.
If we can understand a particular company is making money and enjoying durable competitive advantage, then we consider about its growth over last 7-10 years. Warren Buffett says it is better to consider the pretax profit growth. Furthermore,return on equity, that is net profit divided by shareholders equity, in a long-term competitive advantaged business, as Warren Buffett believes, should be over 12%.
After analyzing all those facts we should evaluate the business. When we evaluate a business share, the rate of growth of the business is compared with prevailing interest rate of a long-term government bond.
Like learn to ride a bicycle while gradually minimizing mistakes, with practicing on investing using above system will give you risk minimized stock market investing.