How to Analyze a Balance Sheet Like a Hedge Fund Analyst
Summary
TLDRThis video offers an in-depth guide on analyzing a company's balance sheet, focusing on assets, liabilities, and equity. It uses Apple as an example to explain key terms like cash equivalents, accounts receivable, and inventory. The presenter also discusses debt analysis, net debt calculation, and the importance of comparing a company's financial ratios with industry peers.
Takeaways
- 📊 Understanding a company's balance sheet is crucial for investors as it can indicate the financial health and potential for bankruptcy.
- 💼 The balance sheet is divided into three main sections: assets, liabilities, and stockholders' equity, reflecting a company's resources, obligations, and ownership interest.
- 🏦 Assets are categorized as current (easily convertible to cash within a year) and non-current (long-term resources), with liquidity being the key to their order in the balance sheet.
- 📋 Liabilities are also divided into current (due within a year) and non-current (longer than a year), indicating the company's short-term and long-term obligations.
- 💰 The basic accounting equation is Assets = Liabilities + Stockholders' Equity, showing how a company's assets are financed.
- 💹 Cash and cash equivalents, including marketable securities, are important to assess a company's liquidity and financial flexibility.
- 📈 Accounts receivable represent money owed to the company, while inventories are products ready for sale but not yet sold, indicating potential sales performance.
- 🏭 Property, plant, and equipment (PPE) are long-term physical assets that can indicate the capital intensity of an industry.
- 💳 Accounts payable and deferred revenue are part of the liability section, showing the money owed to suppliers and the revenue received in advance for services.
- 📉 Commercial paper represents short-term debt used for daily operations, while term debt is longer-term and can affect a company's financial stability.
- 🔢 Net debt is calculated by subtracting a company's cash from its total debt, providing a clearer picture of its financial obligations and ability to meet them.
Q & A
What is the primary focus of the video script?
-The primary focus of the video script is to teach viewers how to analyze a company's balance sheet using the experience of an investment analyst, with the aim of helping investors understand what to look for when investing.
Why is understanding a company's balance sheet critical for investors?
-Understanding a company's balance sheet is critical for investors because it can indicate the financial health of a company, the presence of excessive debt, and the risk of bankruptcy, which directly affects the potential return on investment.
What are the three main sections of a balance sheet?
-The three main sections of a balance sheet are assets, liabilities, and stockholders' equity.
How does the basic accounting equation relate to the balance sheet?
-The basic accounting equation, assets = liabilities + stockholders' equity, shows how the assets of a company are financed, which is the core concept of a balance sheet.
What are current assets and how do they differ from non-current assets?
-Current assets are assets that can be converted into cash within one year, such as short-term investments and accounts receivable. Non-current assets are longer-term assets that cannot be recognized until after one year, like property and machinery.
What is the significance of liquidity in the context of a company's assets?
-Liquidity refers to how quickly assets can be turned into cash. Assets are listed in order of their liquidity on a balance sheet, with the most liquid assets at the top, indicating their ease of conversion to cash.
How does the script use Apple Inc. as an example to explain balance sheet analysis?
-The script uses Apple Inc.'s balance sheet to illustrate key concepts, such as cash and cash equivalents, marketable securities, accounts receivable, inventories, and property, plant, and equipment (PPE), providing a line-by-line breakdown.
What is the importance of accounts receivable on a company's balance sheet?
-Accounts receivable represents the money owed to the company by customers for purchases made on credit. It's important for investors to understand the company's credit sales and collection efficiency.
Why is inventory analysis important for investors?
-Inventory analysis is important for investors to assess whether a company is having difficulty selling its products, as growing inventory levels can signal overproduction or weak demand.
How does the script explain the concept of net debt?
-The script explains net debt as the calculation of a company's debt minus its cash, which gives an investor a clearer picture of the company's actual debt position, considering its liquid assets.
What is the significance of the net debt to EBITDA ratio in evaluating a company's financial health?
-The net debt to EBITDA ratio is significant as it shows how well a company can support its debt through the cash it generates, providing insight into the company's financial stability and efficiency in using capital.
Why is return on equity (ROE) an important metric for investors?
-Return on equity (ROE) is important because it measures how efficiently a company uses its capital to generate profit, providing a comparison of profitability relative to the shareholders' investment.
How does the script use Coca-Cola as an example to illustrate net debt calculation?
-The script uses Coca-Cola's financial figures to demonstrate the calculation of net debt by subtracting the company's cash from its debt, resulting in a net debt figure that can be further analyzed in the context of the company's operations and industry.
Outlines
📊 Introduction to Analyzing a Company's Balance Sheet
This paragraph introduces the video's focus on teaching viewers how to analyze a company's balance sheet, leveraging the presenter's experience as an investment analyst. It emphasizes the importance of a good balance sheet for successful investing and avoiding bankruptcy. The balance sheet's organization into assets, liabilities, and stockholders' equity is explained, along with the basic accounting equation that relates these elements. The paragraph also differentiates between current and non-current assets and liabilities, highlighting the significance of liquidity in asset valuation.
💼 Deep Dive into Apple's Balance Sheet Components
The second paragraph delves into a detailed analysis of Apple's balance sheet, starting with its cash and cash equivalents, and how to calculate the company's 'true cash' position by including marketable securities. It explains accounts receivable as money owed to the company and inventories as finished products yet to be sold. The discussion then moves to property, plant, and equipment (PPE) as indicators of a capital-intensive industry. The paragraph also covers accounts payable, deferred revenue, and commercial paper, concluding with an explanation of how to calculate a company's true debt and net debt, using Apple's financial figures as an example.
🏦 Understanding Debt and Equity Through Apple and Coca-Cola Examples
The final paragraph discusses the importance of evaluating a company's debt in relation to its cash holdings, as demonstrated by Apple's lack of net debt due to substantial cash reserves. It introduces the concept of net debt to EBITDA ratio as a measure of a company's debt sustainability relative to its earnings. The paragraph uses Coca-Cola's financial figures to illustrate how to calculate this ratio and emphasizes comparing it with industry peers. It concludes with an explanation of Return on Equity (ROE), showcasing Apple's high ROE compared to Samsung's, thereby highlighting Apple's capital efficiency and profitability.
Mindmap
Keywords
💡Balance Sheet
💡Asset
💡Liability
💡Stockholders Equity
💡Current Assets
💡Non-Current Assets
💡Liquidity
💡Accounts Receivable
💡Inventories
💡Property, Plant, and Equipment (PPE)
💡Net Debt
💡Net Debt to EBITDA Ratio
💡Return on Equity (ROE)
Highlights
The video provides an in-depth analysis of a company's balance sheet using the presenter's experience as an investment analyst.
A good balance sheet is critical for successful investing and can indicate a company's financial health or bankruptcy risk.
The balance sheet is divided into assets, liabilities, and stockholders' equity, with each having current and non-current subcategories.
Assets are resources with monetary value, while liabilities are obligations the company owes, such as bank loans or supplier payments.
The basic accounting equation is assets = liabilities + stockholders' equity, illustrating how a company's assets are financed.
Liquidity refers to how quickly assets can be turned into cash, with cash being the most liquid and property, plant, and equipment the least.
Apple's balance sheet is used as an example to explain various line items, including cash and cash equivalents, marketable securities, and accounts receivable.
Inventories represent completed products ready for sale but not yet sold, and high inventory levels can signal sales difficulties.
Property, plant, and equipment (PPE) are long-term physical assets, and a high PPE to revenue ratio indicates a capital-intensive industry.
Accounts payable represent money owed to suppliers, and deferred revenue is money received in advance for services not yet provided.
Commercial paper is a short-term debt used for funding daily operations, differing from term debt which is longer-term.
Net debt is calculated by subtracting a company's cash from its total debt, indicating the company's actual debt burden.
Apple's net debt is negative, meaning it has more cash than debt, a financially healthy position.
Coca-Cola's net debt and its net debt to EBITDA ratio are used to illustrate how debt is evaluated relative to a company's earnings.
Return on Equity (ROE) measures how efficiently a company uses its capital to generate profit, with a higher percentage being better.
Apple's ROE is significantly higher than its competitor Samsung's, demonstrating its superior business efficiency.
The video concludes with the importance of understanding a company's balance sheet for informed investment decisions.
Transcripts
in this video we are going to go over
how to analyze a company's balance sheet
i'm going to use my experience as an
investment analyst at a large investment
firm to help you guys better understand
what to look for when investing whether
you are a new investor just buying your
first stock or if you've been investing
for years i guarantee if you stick
around till the end of this video you
will learn something new and useful that
you can begin applying to your own
investment research process today now
let's get into the video
understanding the inner workings of a
company's balance sheet is absolutely
critical when investing a good balance
sheet can mean the difference between
losing all of your money when investing
or having a successful investment if a
company has too much debt or runs out of
cash and can't fund its operations that
means the company could be heading for
bankruptcy if that happens there is a
solid chance that your investment in the
company is going to zero
the first thing you need to know about a
balance sheet is that is organized into
three sections assets liabilities and
stockholders equity put simply an asset
is any item or resource with the
monetary value that a business owns cash
that the company has in its bank account
or the factory where the company
manufactures its products would both be
examples of assets the opposite of an
asset is a liability put simply a
liability is something that the company
owes things such as a loan from a bank
or payment that the company owes to one
of its suppliers are both examples of
liabilities the basic accounting
equation is assets equals liabilities
plus stockholders equity this equation
pretty much means that liabilities plus
stockholders equity represents how the
assets of a company are financed now i
don't want to get too deep into
accounting in this video but just keep
this equation in mind as we go
throughout the rest of this video
both the asset section and the liability
section are further broken up into two
subcategories current and non-current
current assets are those that you can
convert into cash within one year such
as short-term investments and accounts
receivable non-current assets are
longer-term assets with a full value
that you cannot recognize until after
one year such as property and machinery
for liabilities current liabilities are
liabilities that are expected to be paid
off within one year while non-current
liabilities are liabilities the company
expects to have for longer than one year
it's also interesting to note that
assets appear in the order of their
liquidity liquidity is just a fancy word
for how quickly assets can be turned
into cash cash is the most liquid asset
because well it's already cash the most
liquid assets are at the top and the
least liquid assets like property plant
and equipment for example are at the
bottom of the asset section so now that
we have that background and why the
balance sheet is so important let's go
line by line of a company's balance
sheet and talk about what you need to
know in this example we are going to be
using apple but first a quick word from
our sponsor masterworks if you follow my
channel you probably know how turbulent
the market has been with inflation
hitting a 30-year high many professional
investors are either trying to find ways
to significantly outperform the market
over the long term or hedge against
inflation regardless if you want to
understand what the sharpest minds in
investing are doing right now you need
to check out masterworks masterworks
lets you invest in an asset class that
has outpaced the s p 500 by 174
from 1995 to 2020. that's 25 years
and has seen almost triple the
appreciation of real estate gold and 90
of cryptocurrencies during that same
time so this may surprise you but the
asset class i'm talking about is
contemporary art the only problem
historically it's been impossible to
invest in high end art unless you're in
the one percent of the one percent well
that is of course until now masterworks
lets ordinary people like you and me
invest in multi-million dollar artworks
for just a fraction of the cost by
letting investors buy shares just like
stock and the artwork and getting
started with masterworks is super easy
all it takes is a few clicks you just
make an account browse their artwork and
add it to your investing portfolio
masterworks also offers a secondary
market on their website where you can
sell your shares to another member
luckily by partnering with masterworks
they've given me a link that lets you
skip their massive waitlist which you
can find in the description below okay
now back to apple's balance sheet the
first line that i want to talk about is
cash and cash equivalents the first part
of this line is pretty self-explanatory
cash is just the money that you have
sitting in a checking or savings account
the part that needs some explaining is
cash equivalents cash equivalents are
short-term and super safe investments
that can easily be turned into cash the
reason companies put their money into
these short term but extremely low risk
investments is to earn a little extra
money think about it if you're apple and
you have tens of billions of dollars of
cash if you're able to get even a very
small return on your money that is
millions of dollars of extra cash you
are generating moving down the balance
sheet we have marketable securities this
is where the analysis really starts to
take place these marketable securities
are already low risk and can be turned
into cash relatively easily marketable
securities consists of things like
government bonds when i'm trying to
calculate a company's true cash i always
like to add the marketable securities
into the cash and cash equivalence line
so we can see at the end of 2021 apple
had 34
cash and cash equivalents twenty seven
thousand six hundred and ninety nine
dollars in marketable securities and one
hundred and twenty seven thousand eight
hundred and seventy seven dollars and
non-current marketable securities if we
add these three numbers together we get
thousand 190
hundred and sixteen dollars the reason i
add these numbers together is because i
want to determine how much true cash the
company has relative to its debt as well
as how much cash the company can use to
do things such as buy other companies
pay dividends or repurchase stock
next up we have accounts receivable
accounts receivable is the amount of
money owed to the company by customers
for purchases made on credit let's say
you own a lemonade stand one of your
customers asks you to supply lemonade to
a party he's hosting let's say you
supply 20 worth of lemonade to the party
and the customer says to send him over
the bill for 20 and he will pay you next
week this is an example of an accounts
receivable from the time you provided
the lemonade to the customer but have
yet to receive payment you have a 20
account receivable from the customer so
in the case of apple if they are selling
their iphones to a large corporate
customer but are awaiting payment this
would show up on the balance sheet as an
accounts receivable the next line i want
to cover is inventories these are
products that are completed and ready to
be sold but have yet to be sold to a
customer so in the case of apple it
would be the iphones ipads and macbooks
that have been manufactured but have not
yet been sold to customers as an
investor you want to make sure that
these inventory levels aren't growing
significantly as it can be a sign that
the company is having a difficult time
selling its products for example one of
apple's rivals microsoft had this
problem a while back back in 2013
microsoft took a loss of nearly 1
billion dollars on one of its products
because the company simply overestimated
demand they made way too much of the
product because the company thought
demand from customers was going to be
higher than it turned out to be
microsoft investors were left footing
the bill of nearly 1 billion
now microsoft has since recovered and
made that money back in a week or two
however for a company such as a retailer
or department store this inventory line
is extremely important because if a
retailer or department store misplans
their inventory it can have devastating
consequences i now want to jump to the
line titled property plant and equipment
property plant and equipment or pp e for
short are physical assets that a company
owns that typically have a life of
longer than one year this can include
things like vehicles furniture computers
machinery buildings or land for apple an
example of this would be its 5 billion
headquarters that it built called apple
park the larger this pp e number is the
more capital intensive an industry is
examples of capital intensive industries
include railroads oil companies and auto
manufacturers a good way to see how
capital intensive an industry is is to
divide pp e by the company's annual
revenue this shows you how much property
plant and equipment it took a company to
generate a certain amount of revenue for
example if we do this analysis with
apple we see that property plant and
equipment is 11 of annual revenue this
is a relatively capital light industry
the opposite of a capital intensive
industry
however let's try this with a railroad
let's use union pacific which is a
railroad covering the western part of
the united states if we do the same
calculation we get a value of 277
percent this shows just how much more
capital intensive union pacific is
compared to apple
now i want to jump to the liability
section of the balance sheet the first
line i want to touch on is counts
payable think of this line as the
opposite of accounts receivable accounts
payable is money that apple owes to its
suppliers for products and services
apple has received but has not yet paid
for
so for example let's say the company
that makes a glass for the front of the
iphone sent apple 100 million dollars of
glass during the month apple has
received the glass from its supplier but
until apple pays the supplier for that
material the amount apple owes in this
case 100 million dollars shows up in the
line titled accounts payable the next
line item i want to touch on is deferred
revenue this is an important line item
for software companies and many tech
companies the easiest way to explain
this is with netflix so when you sign up
for netflix the company bills you up
front let's say 15
you pay 15 at the beginning of the month
and that allows you to access netflix
for the entire month however because of
accounting rules the company cannot
classify that 15 you pay them as revenue
until they provide the service to you so
in this example provide you with a month
of access to netflix so that 15 will
show up in deferred revenue until after
the company has provided you with the
promise service this is very common in
subscription-based software businesses
like netflix microsoft adobe and
salesforce in the case of apple this
deferred revenue would come from their
services business like apple music and
icloud storage
next up is commercial paper this is
simply very short-term debt around only
30 days until the company has to pay it
off companies use commercial paper to
fund the daily operations of their
business such as payroll paying
suppliers and things like that the
biggest difference between commercial
paper and the next line term debt is
that commercial paper is just super
short-term loans
this brings me to the most important
part of analyzing a company's balance
sheet understanding the company's debt
in the case of apple their data is
listed as three separate lines
commercial paper the current portion of
term debt and the non-current portion of
term dot just a reminder that current
means the debt is due within 12 months
while non-current means due at a time
longer than 12 months in order to
calculate what i refer to as apple's
true debt we have to add these three
lines together adding together the six
thousand dollars of commercial paper the
nine thousand six hundred and thirteen
dollars current portion of debt and the
one hundred and nine thousand one
hundred and six dollars non-current
portion of debt we see that apple's true
debt is 124
719
however i want to take this analysis one
step further so now that we have apple's
true cash that we calculated earlier and
the company's true debt we now want to
calculate what in the investing industry
is referred to as net debt it's a super
easy calculation just take the company's
debt and subtract out the cash the
company has this leaves you with a net
amount of debt if we do this with apple
we get
seven negative 65
ninety seven dollars this means that the
company in theory does not have any debt
on its balance sheet because its cash
exceeds its debt it's important to
subtract out the cash a company has from
its debt amount in order to see how much
net debt the company has that it can't
pay right away in the case of apple even
though the company technically has 124
billion dollars of debt they really
don't because they have far more cash on
the balance sheet than debt at first
glance you as an investor might be
worried about that large set amount of
124 billion dollars but once you
understand that apple has cash of 190
billion dollars you suddenly aren't so
worried about that number at all anymore
in order to illustrate my point let's
use another company as an example
coca-cola coca-cola has
seven hundred and ninety three dollars
in debt and ten thousand nine hundred
and fourteen dollars in cash in order to
calculate coca-cola's net debt we take
the debt amount and subtract out the
cash amount this leaves us with a net
debt amount of thirty one thousand eight
hundred and seventy nine dollars so this
leaves an important question for us as
an investor is this a large nut debt
figure or not that completely depends on
how much money the company makes if the
company makes 10 billion dollars a year
in profits one billion dollars in debts
would be a relatively small amount of
debt however if a company only makes 100
million dollars in profits a year that
same one billion dollars in debt would
probably crush it and cause it to go
bankrupt a helpful analysis to do in
order to determine whether a company can
support its debt through the cash it
generates is to calculate its net debt
to ebitda ratio this is a pretty
straightforward calculation you take the
company's net debt and divide it by its
annual ebitda which is what we usually
use as a proxy for cash flow
if you want to learn more about ebitda
and how to analyze an income statement
check out the video i did on it here
coca-cola had an ebitda of 10 533
dollars in 2020. by taking coca-cola's
net debt and dividing it by this ebitda
amount we get a net debt to ebitda ratio
of
3.03 the best way to analyze this number
is to compare it to that of the
company's competitors in the same
industry this is because different
industries use varying amounts of debt
to fund the operations of the company it
wouldn't make sense to compare
coca-cola's net debt to ebitda to a
high-growth software company but it
would make sense to compare it to other
consumer package good companies like
nestle or procter gamble now i'm not
going to spend a ton of time talking
about the shareholder equity section
because pretty much all of your time as
an investor should be spent better
understanding the assets and the
liabilities of a company however there
is one investment metric that i do want
to bring your attention to that metric
is return on equity and it is calculated
by taking a company's net income from
the income statement and dividing it by
the company's total shareholders equity
return on equity tells you how much net
income a company generates per dollar of
invested capital this percentage is key
because it helps investors understand
how efficiently a firm uses its capital
to generate profit so for apple we take
the company's net income for 2021 of
thousand six hundred and forty dollars
and divided by the total shareholders
equity of sixty three thousand ninety
dollars this leaves us with a return on
equity of one hundred and fifty percent
generally speaking the higher this
number is the better the most useful
thing to do for this number is to
compare to that of the company's
competitors in the same industry samsung
is one of apple's competitors want to
take a guess on what their return on
equity is
seriously take a guess
well samsung's roe is 17
this demonstrates just how great of a
business apple is it is able to generate
a ton of money in profits with
relatively little shareholders capital
no wonder apple is the most valuable
company in the world so there you have
it make sure to give this video a like
and subscribe to the investor center and
if you want to check out the other
videos in this series including how to
analyze an income statement and a cash
flow statement check it out here talk to
you guys soon
Посмотреть больше похожих видео
Statement of Financial Position (SOFP) | Laporan Posisi Keuangan | Akuntansi Keuangan Menengah
Balance Sheet
FINANCIAL STATEMENTS: all the basics in 8 MINS!
How to identify Good Stocks in a falling market | Akshat Shrivastava
FA30 - Merchandiser's Financial Statements - Balance Sheet
Stock Market for Beginners: Must know Financial Ratios Before Investing in a Stock | CA Aleena Rais
5.0 / 5 (0 votes)