Today I’ll be continuing the multi-part series Investing for Beginners.  Don’t forget to read the first part, Stock Market Basics if you haven’t already.  If you want to keep updated with new additions to the Investing for Beginners series then don’t forget to subscribe to the Debit versus Credit RSS feed.  Today I’ll be covering a little bit about Accounting, specifically how to analyze financial statements.

Now hold on!  Before you run away let me explain.

I realize that most of you are probably not especially fond of accounting, especially after having to endure the hell that is debits and credits. If you do enjoy accounting you are a member of a small minority and I congratulate you. As for the rest of us (myself included) accounting is much too tedious and sometimes even a little bit confusing. That’s not what we’re here for today, though. Today I will be teaching accounting, this much is true. I will only be teaching what is necessary for the dissection of financial statements, which can then be applied to researching a company that you might be interested in investing in. I promise it will be easy but more importantly it will be useful and FUN!

The only accounting that you should ever have to do when it comes to researching investments is as simple as reading existing financial statements.  I am going to provide examples of an income statement today and on the next update I’ll cover the balance sheet and cash flow statements.  I’ll point out what’s important and how you can use these statements to analyze how well a company is doing financially.

The Income Statement

With the Income Statement we want to pay attention to several numbers, with Gross Profit and Net Income being the most important.  This is an annual report which lists the Net Income for the years ended Sep 24 of 2005, Sep 30 of 2006 and Sep 29 of 2007.  This means that the income and other figures listed are from the fiscal year beginning in October and ending in September of the following year.

What do the numbers mean?  And what do we do with them?  There are some relatively obvious ways to dissect this Income Statement.  For example Apple’s net income for the year ended September 2007 was $3,496,000,000 ($3.5 billion) dollars.  If you compare this to the previous year ($1.9 billion dollars) then it seems that Apple is doing something right.  But we’re doing something wrong.  Comparing dollars to dollars isn’t usually the best way to read financial statements, as it’s akin to comparing apples and oranges – especially when trying to compare Apple’s net income against say Dell’s or Microsoft’s.  So how do we do it?

Use percentages!

Let’s look first at Apple’s Gross Profit for the year ended Sep ’05.

It’s $4,043,000,000 (the numbers are in thousands).

Now look at their gross profit the following year.

It’s $5,598,000,000.

Now divide the most recent year (that you’re looking at) by the previous year (2006/2005) and you get a number (1.38) which if put into percent format shows you that Apple made 138% of the profit that they made in 2005 in the year 2006.  In other words they made 38% more in 2006 than they did in 2005.

What’s this number like for 2007?  Just divide 2007/2006 and you come up with a 45% increase over year 2006.  This is a good thing! Their gross profit percentage is trending upwards, meaning that it is increasing year after year.

Now let’s check out their net income.  For the year 2006 they posted an increase in their net income (over 2005) of 49% and for the year 2007 an increase over 2006 of 75%.  These numbers are amazing! It was good that their gross profit was trending upwards with some high percentages, but the net income percentages are even larger!  Essentially this means that their income is increasing at a higher percentage than their expenses are.  Check out their “selling and general administrative” costs if you don’t believe me.  30% and 21% – that’s how much selling and general administrative costs increased.

Based on what we’ve seen with Apple’s income statement they’re in a great position, in terms of growth.  Their Gross Profit and their Net Income has been increasing at a steady rate over the past several years.  If they can continue with this level of growth then it’s almost a given that the AAPL share price will continue to increase over the months and years.  After all as long as a company is growing, then shouldn’t their share price continue to grow also?  Technically yes, but there’s a lot more that goes into share price than just profit.  Stay tuned for more Investing for Beginners!

That’s going to be it for today. Don’t forget to subscribe to the Debit versus Credit feed so you can make sure to receive updates to the Investing for Beginners series as they are posted!

This is the first of a multi-part series entitled Investing for Beginners.  Over the next several parts of this series I’ll be covering basic skills needed for investing such as Accounting, Economics and Stock Market Basics.  Today I’ll begin with Stock Market Basics.

An accounting professor of mine once told me that if anyone wants to be successful with investing they can be.  Stock Market Basics truly are not a difficult thing to learn.  At its core the Stock Market is essentially a free market system, meaning that it’s based on forces pulling against each other; these forces are supply and demand.  As a beginning investor it’s important to remember that these pulling forces are based on several things, such as a companies fundamentals (revenue, profit, assets, liabilities), technical evaluation and even “acts of god.”  To be able to interpret these market forces and company profiles requires some knowledge in accounting and economics and also a desire to keep up on stock market and company news.  Thus Stock Market Basics can be learned by education, which is the foundation for success as an investor.

Investing for Beginners: What Is The Stock Market?

I’ll liken the stock market to an auction.  If an auctioneer has 50 widgets for sale he or she is likely to start the bidding out at a price that’s much lower than if he or she had only 1 widget to sell.  The more the auctioneer has to sell (supply) the less they are probably going to sell for because buyers (or demand in this case) are limited (based on price, supply, etc).  The stock market is similar to this.  However instead of buying a product or service the buyer actually buys ownership in a company.

The way that the market works is actually strikingly similar to an auction.  Brokerage companies (companies through which you can purchase stock of other firms) often have representatives on the floor of all the major stock exchanges, such as the New York Stock Exchange (NYSE).  These representatives could be thought of as auctioneers.  They take orders from those who want to buy stock and they take orders from stockholders who want to sell their stock.  They then match up orders and, voila!  A stock trade has taken place.

So What Do I Do First?

In order to start trading stocks you’ll need to open an account with a brokerage firm such as Scottrade, Charles Schwab, Sharebuilder or Zecco.  I personally recommend Zecco as they offer 10 free trades a month with a balance of $2,500 or more in your brokerage account.  If you want to open an account at either Scottrade or Sharebuilder shoot me an e-mail.  I think they offer incentives for referring friends – both to the referrer and the refereed. If you’re interested in Zecco (my personal recommendation) then you can follow the affiliate link below to sign up.

Next you’ll want to think of a company that you want to invest in.  Ideally it should be something that you know a little bit about, or support as a company.  Then you would do some research on them.  For example (and we’ll use AAPL because it’s a favorite of mine) if I wanted to buy shares in Apple I would first do some research on the company to discover for myself if I think they will continue to be profitable in the future.  A good (but very general) rule of thumb is that as long as a company continues to increase their earnings they will continue to grow and so will the value of their stock.

Prices Fluctuate, So Don’t Panic!

It’s important to remember that even though over the long-run (we’re talking years, not months) the value of a stock is based almost entirely on fundamentals, the share price of a stock is still subject to irrationality and bubbles.  In other words if I were to buy 100 shares in AAPL today, expecting to hold it for 5 years before I sell it, I can expect that the share price will, over the days and the months, have its ups and its downs.  I should be confident, however, that my decision to purchase an ownership (through 100 shares of stock) in Apple will pay off in the long-run.

Investing is not something that should be taken lightly.  If a friend of yours gives you a tip that they think a certain stock is going to go way up, you probably shouldn’t listen to them.  For example, I had a friend who recommended I pick up some SIRI (Sirius Satellite Radio) years ago when they first signed on Howard Stern.  Back then the stock price was somewhere in the teens… today it’s a penny stock.  His “hunch” wasn’t right, and your friends’ hunches probably won’t be right either.  Don’t trust anyone except yourself, your gut and your wallet when it comes to investing.  This way if you make a stupid investment (and we all do at some point) you’ll have no one to blame but yourself AND you’ll be able to learn from your mistake.

This concludes part 1 of the Investing for Beginners series, Stock Market Basics. Check out the next post in the series on Investing for Beginners.