Cash Flow

A company reports its net income after tax (net profit) on the income statement. That net income is reduced if the company is subtracting large amounts for depreciation/amortization. If a company bought a printing press for $1 million cash a while ago, they might be subtracting $100,000 a year until they've written down the cost to zero, in order to spread the cost over the useful life of the equipment. But those subtractions now are not cash--they are a reality check. Since depreciation/amortization is a non-cash subtraction on the income statement, analysts often add back that subtraction to the net income in order to estimate how much cash the company is generating.

In the 10K, the company shows its balance sheet and income statement, and also a statement of cash flows. There are three ways a company can use or generate cash each year: operations, investing, financing. A company can generate or use up cash operating its business, but also by investing in equipment (or selling it off) or issuing securities (or buying them back). So, if the company's cash position increases, analysts would note perhaps that it's simply due to a recent offer of stock or convertible debentures (financing). If the cash position drops this year, maybe it's only because the company wisely invested cash into better equipment (investing). For extra credit "google" a public company's 10K and read thru the consolidated financial statement and the notes to it. It could REALLY help you on a few test questions. NEED HELP with your exam?

Hospira?

I've mentioned that the exit strategy for my little foray into margin loans is the inevitable rise of Hospira common stock. If Hospira rises to $55, I can sell my 90 shares, pay back the margin loan and continue to hold the other shares I currently hold in an IRA. But, what is this "Hospira" I keep referring to? It's a former unit of Abbott Labs, which is another stock I own (and love). Hospira was spun off from the parent comany, which is where I got my initial dose of the stock. Later, when I became the executor of my mother's estate, I purchased 270 shares, or 90 for me and each of my two sisters. Hospira is a very simple, straightforward company--basically, they make injectables and I.V. systems for use in hospitals, clinics, and in-home care. In the past five fiscal years, their sales/revenue came in at about $2.64 billion, $2.62 billion, $2.68 billion, $3.43 billion, and $3.63 billion. Their net income (profit) has been anywhere from $107 million to $321 million most recently. The stock is not trading expensively--like most stocks these days--at only 13 times earnings. It earns $2.61 per share but--like many companies--pays no dividends. How do you make money on a stock that pays no dividends? You wait for it to rise in value, at which point you can sell for a capital gain or, perhaps, the company eventually does start paying dividends, making it both a growth and an income investment. From a technical standpoint, the short interest is very low in the stock; only about 2.5% of the shares have been sold short. The 52-week high is about $42; the 52-week low is about $21. Lately, it's on an uptrend: +7% last 5 days, +8% last 30 days, +15% last 60 days. What does this all mean for my chances of Hospira rising to $55 or higher, allowing me to sell and pay back the $5,000 I borrowed from my margin account? No idea. Luckily, the exam doesn't expect you to know something like that. The exam just wants you to have an idea what earnings and P/E ratios might be, which stocks are generally more volatile and which are generally more stable, that sort of thing. Being able to relate some of this exam material to the real world will give you a big edge when studying, so I encourage you to look up some of your favorite companies and look for testable points. Glance at the income statement, click on the "overview," and have yourself as much fun as I'm currently having at about 5 AM on a cold, dreary morning in early June.

Income Statement and Balance Sheet

The Series 65 and 66 will likely ask several questions requiring you to know the difference between a company's income statement and balance sheet. A company's income statement shows the results of operations over a financial quarter or over the fiscal year. It starts with revenue then deducts every cost and expense including taxes until we get to the "bottom line," known as "profit" or "net income after taxes." If you want to see the company's sales (revenue) and profits, look on the income statement.
If you want to see the company's financial health, look at the balance sheet. The balance sheet is a snapshot of the company's financial condition. Assets such as cash and securities, inventory, and equipment are listed on the "plus side," with liabilities such as deferred wages and accounts payable listed on the "minus side." The difference between a company's assets and liabilities is the net worth of the company, called "stockholders' equity" or "shareholders' equity."
Who reads income statements and balance sheets? Fundamental analysts. A fundamental analyst looks at the fundamentals of the company, including: revenue, earnings-per-share, book value, dividend payout, and profit margins. A fundamental analyst studies financial statements. He or she could invest in growth stocks, value stocks, a blend of each, whatever. But if he arrives at his stock picks through this school of thought, he is a fundamental analyst, and he is an active investor. A passive investor would not try to pick one company over another--he or she would use indexes almost exclusively.
Many students struggle with the difference between fundamental and technical analysis. We've already sketched fundamental analysis. Notice how it involves looking at a company's fundamentals. Technical analysis, on the other hand, studies the market data connected to the stock itself. A technical analyst doesn't care what the company makes or does, he just tracks the movement of the company's stock in terms of price, volume, and other market data. If he's talking about support and resistance, the 200-day moving average, or a head-and-shoulders pattern, he's a technical analyst. He's just tracking the stock price or movement of a particular index. A fundamental analyst, on the other hand, studies a particular company or industry sector in terms of sales, profits, growth trends, etc.

Practice Questions step-by-step

As I mentioned in the previous post, your job is not to look for the right answer. Your job is to find and elminate as many WRONG answers as possible. Let's apply this strategy to the following question:

Which of the following can be determined by looking at a corporation's balance sheet?
I. EPS
II. net income
III. quick ratio
IV. shareholders equity
A. I, II
B. II, III
C. III, IV
D. I, II, III, IV

Step one, read the answer choices A, B, C, and D just to see how the little Roman Numerals have been distributed. Right away, you see that this question either has a "I" in it, or it doesn't. Once we make that decision, two answer choices will be eliminated.
Or, for the extreme strategists, notice that three answers have a "II" in it and three have a "III" in it. If you could eliminate either "II" or "III," then, you would be done.
I know, some of you are thinking--but that has nothing to do with learning the information!
So what? Neither does the friggin' Series 65 or Series 66. It's just a hazing ritual that the regulators use to keep a certain percentage of folks out of the business and, thereby, claim to be "providing necessary protection to investors."
It's a game, people. Play it with strategy, win it, and move on with your lives.
So, as an extreme strategist myself, I have to go for the knockout punch here. I'm looking at choice "II" and choice "III" first.
Choice "II" says "net income."
Hmmmmmmmmmmmmmmmmm.
Where would net INCOME be found? Perhaps on the other financial statement called the INCOME STATEMENT?
A-ha! This question is just a bully and is about to get its butt kicked. There is a balance sheet, and there is an income statement. Net income is on the INCOME STATEMENT, not on the balance sheet. So, let's eliminate any answer choice with a "II" in it.
Let's see, that eliminates Choice A, B, and D.
Leaving us with the right answer, C.

People who say they "hate the Roman Numeral questions" aren't using strategy. These so-called "multiple multiples" are, by far, the easiest type of question to answer. You just have to be patient and analytical.

Send in a hard Series 65/66 question, and I'll break it down for the community step-by-step.