Annual report

Contains useful historical information about a company but is out of date as soon as it is produced. That said the balance sheet is useful for learning the size of a company, how much capital it has issued, how much money it owes and what assets it possesses. Its limitations are that it is:

• only a snapshot of the company on one particular day
• the value of assets such as property and equipment is at best arbitrary
• it may not reflect the true value of "intangible" assets such as brands, the skills of its staff or its intellectual property

Income statements

Also part of the annual report aka profit and loss account it records the income and expenditure over the company's accounting period. It shows income and expenditure in ordinary trading activities as well as in extraordinary activities such as disposals of subsidiary companies for example.

Income statements are useful in showing the earnings of a business both at the gross level and after various deductions. Net profit is what is available to the directors to distribute to shareholders.

The notes to the accounts

These are as important as the numbers themselves. They contain a great deal about how the company manages itself such as how much the directors are paying themselves, for example.

Website

The company's website should show more recent quarterly or half yearly figures. There may be latest news from the company on its plans for the future and changes in management.

Ratios

Ratios help evaluate companies and how their managers are performing. The most commonly used ratios are:

• Earnings per share (EPS): a company's after tax profit divided by the number of shares it has issued. If a business has a high EPS this may mean plenty of dividends to distribute to shareholders. This doesn't necessarily follow but it does enable us to compare one company with another.
• Price / earnings ratio (P/E) is worked out by taking a company's share price and dividing it by its EPS. So if the share price is €10 and it has an EPS of 20 (i.e. 20c) the P/E is 50. This would be considered as quite high, suggesting that the price of the share was expensive as compared with the company's earnings but everything is relative. The important thing is comparison with other businesses.
• Return on equity (ROE) is used to measure profitability. It demonstrates how much profit the managers of a business are generating per unit of shareholders' equity.

A simple analysis of a company's strengths, weaknesses, opportunities and threats (SWOT) is a forward-looking view of the business and the competitive environment in which it operates.

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    • What is the company good at?
    • What are its competitive advantages?
    • What are the strong qualities of its management team?
    • What great products does it have?
    • Does it have undervalued assets?
    • What is it saying about its achievable goals for the future?
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    • What bad news do we know about the company?
    • Are its products, management, assets or achievable goals for the future weak in any way?
    • What are its competitive disadvantages as compared with its peers?
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    • This is where we can look at the prospects for the business. What does the future hold for the company if its game plan works out?
    • How could it grow its earnings?
    • What new products could it offer?
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    • What are the challenges to its abilities to fulfil its goals?
    • Are they economic, commercial, legal?
    • Are there obvious dangers that the company faces in following its chosen business strategy or model?
Strengths:



Weaknesses:

Opportunities:

Threats:

Once you've read everything you can about the business, calculated its ratios and run a SWOT you may be able to project some of the numbers to estimate its future performance.

Although this is by no means the last word in risk free investing at least through this analysis we should end up with a pretty good understanding of the business and be able to make some well-informed judgements about whether it looks worth investing in.

Richard Willsher is a London-based finance and investment writer. With a background in investment banking he has written for the Financial Times, the Wall Street Journal and is former editor of The Investor.