How (and why) to read a financial report

A basic knowledge of a company’s financials can help you better understand the health of your investments.

Tags: Investing, Investments
Published: March 23, 2021

Simply put, a company’s financials can be intimidating. But if you have a 401k, own stocks as investments or want to start investing, a basic knowledge of a company’s financial performance can help you better understand the financial health of your investments.

 

Key takeaways

  • Products and services sold show how money is made
  • Strategy and vision indicate next moves
  • Key financial numbers indicate the state of financial wellness
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Show me the business

Read about the company’s products and services to better understand what the company does – and how it makes money. Look for a breakdown of the percent of revenue generated from each area.  There may be a surprising diversity of products and services a company offers.

 

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Show me the future (vision)

In lieu of a crystal ball, a great way to understand where a company is headed is to read the commentary in the earnings reports, transcripts from investor events, and the annual report. All of these give insights into the leadership’s vision and strategy for the future. They may also signal a period of growth or change for a company.

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Show me the money

There are key reporting measurements in every industry that indicate how a company is doing financially. In banking, for instance, three key metrics are often used to give a high-level assessment of performance.

  • Return on average assets (ROA) shows how efficiently assets are used to make money. Assets are things the company possesses and can be tangible like buildings and land or more abstract like loans and investments.
  • Return on average common equity (ROCE) tells how much profit is made on the money shareholders invest – and a higher ROCE generally makes a company more attractive for investors.
  • Positive operating leverage simply means that a company’s revenue is growing faster than its expenses. The larger the gap between the rates of growth of these two numbers shows the company’s effectiveness at growing its profitability.

 

See if you can apply these learnings to the U.S. Bancorp annual report