Wise stock market investment requires the investor to purchase the earnings growth or capacity utilization of companies. While value investors like to purchase the stocks of larger companies, looking for bargains as they focus on company valuation; growth investors look at factors suggesting continued high growth (Company Selection). However, both kinds of investors tend to perform ratio analysis whilst in the process of company selection.
Ratio analysis refers to the comparison of numerical figures from the balance sheet, income statement, and cash flow statement of the company in question, against numerical figures in the same categories gathered from other companies, the industry as a whole, or even the economy at large (Ratio Analysis, 2007). The statement of cash flow, which forms the basis of the important solvency ratio analyzed by the investor, is a financial report showing the investor a company’s incoming and outgoing money during a particular period of time. This report is a very useful tool for the investor to evaluate a company’s financial soundness (Cash Flow, 2007).
Company selection requires the investor to focus on either or all of the following factors: (1) earnings growth, taking the company’s competitors into account; (2) company valuation, i.e. the
COMPANY SELECTION, RATIO ANALYSIS, AND STATEMENT OF CASH FLOW Page # 2 company’s market price relative to its book value; (3) the financial soundness of a company determined by its cash flow statement as well as its decreasing or increasing debt, etc; and (4) diversification, i.e. the consideration of investment in several companies or industries (Company Selection).
Ratio analysis is an essential part of company selection. Leverage ratios, liquidity ratios, operational ratios, profitability ratios, and solvency ratios are all important indicators of an investor’s future success or failure with a particular company (Financial Ratio).
Finally, the investor concentrates upon a company’s statement of cash flow while in the process of company selection. This financial report is extremely useful in analyzing the short-term viability of a company. Descriptions of operating, investing, and financing activities in this report help the investor to come to a final decision about whether to invest in the company or not (Cash Flow).
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Cash Flow Statement. (2007). Wikipedia. Retrieved from http://en.wikipedia.org/wiki/Cash_flow_statement. (6 March 2007).Company Selection. Retrieved from http://www.inv.com/index.htm. (6 March 2007).Financial Ratio Analysis. Retrieved from http://www.finpipe.com/. (6 March 2007).Ratio Analysis: Introduction. (2007). Investopedia. Retrieved from http://www.investopedia.com/. (6 March 2007).