July 9, 2010

Balance Sheets – A Stock Trading Secret Weapon

By Planet Wealth

pa title=Stock Traders href=http://www.trading.com.au target=_blankStock traders/a donrsquo;t require an MBA to quickly assess a companyrsquo;s balance sheet.nbsp; But they can use them to uncover valuable stocks./p
pThere are two halves to a balance sheet: assets, and liabilities plus shareholdersrsquo; equity. The two must balance./p
pAssets include:/p
ul
listrongCurrent assets/strong are those the company expects to use within twelve months, such as cash on hand, inventory, and accounts receivable. In particular, a healthy balance sheet should include a comfortable margin of cash on hand./li
listrongLong-term assets/strong are those the company will use over a longer length of time. This includes land, buildings, machinery, other equipment, and long-term investments. Some industry sectors require significant amounts of capital equipment, such as manufacturing or transportation. Other sectors, such as software and technology firms, have much lighter long-term assets on their balance sheets./li
/ul
pLiabilities include:/p
ul
listrongCurrent liabilities/strong are those due within twelve months, such as salaries, expenses, and small-term debts./li
listrongLong-term liabilities/strong are those expensed over a longer length of time, such as a mortgage or loan for the buy of capital equipment. In the current tight credit environment, long-term debt is generally considered the most vital liability, as itrsquo;s become harder for companies to refinance such loans when necessary./li
/ul
pFinally, strongshareholdersrsquo; or ownersrsquo; equity/strong is the difference between total assets and total liabilities. Itrsquo;s whatrsquo;s left over for investors once the companyrsquo;s debts have been covered, and includes earnings to be paid out as dividends./p
pA company in excellent financial health will show:/p
ul
liCurrent assets that are strongat least 1.5 times/strong the value of its current liabilities. This ensures the company can pay its bills over the next twelve months, although it doesnrsquo;t ensure a profit. If liabilities are equal to, or higher than, assets, the stock has small selling potential./li
liLong-term liabilities of strongno more than 30%/strong of shareholdersrsquo; equity. Any number higher than that indicates significant leverage, which is a risky way to grow a company and may signal another small selling opportunity./li
/ul
pA healthy balance sheet is evidence of a excellent company for a long trade. Any red flags indicate a potential small selling opportunity. Besides the two potential problems mentioned above, other red flags include:/p
ul
listrongFast growth in accounts receivable./strong This means the company is extending significant amounts of credit to go its products. If therersquo;s ever distress collecting, the company may experience a cash flow problem when itrsquo;s time to pay their own bills./li
listrongA significant increase in inventory./strong A growing stockpile indicates that sales arenrsquo;t keeping up and there may be a problem with the companyrsquo;s products or sales efforts. This can be a particular worry in the technology sector, where advances make products obsolete astonishingly quickly./li
/ul
pThese balance sheet basics can help uncover stocks that are undervalued within their industry sector, or those overvalued and ready for shorting. a title=stock traders href=http://www.trading.com.au target=_blankStock Traders/a often refer to them as their secret weapon./p

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