How Value Investors Use Financial Statements to Understand a Business

During their recent episode, Taylor, Carlisle, and David Samra discussed How Value Investors Use Financial Statements to Understand a Business. Here’s an excerpt from the episode:

[David] I had an accounting professor at Columbia Business School way back in 1993, Sandy Burton. And Sandy taught us to make the numbers sing. You’re not just looking at a set of variables, you’re looking at a set of figures that help explain what the business is all about.

And maybe that today is perhaps why we continue to build our own financial models, because you can… And if you build them over a long enough time period, you really… One, you internalise them literally by putting the numbers into the spreadsheet and you’re looking at each number and thinking about it.

And two, as you go through a number of years, you can detect a number of trends. Is this business getting better? Is it getting worse?

Are they doing more deals? Are they doing less deals? What’s happening with the return on capital over time?

You can really get a sense for the business. And oftentimes, when I first come across something that I’m interested in, let’s say through a screen, I’ll start at the back of the annual report and read my way towards the front, because even just going through, let’s say the first 25 pages of the annual report from the back, you learn a lot about the business, not even really knowing what they do. You learn a lot about the economics of the business.

Are there seven pages of legal liabilities in the back of it? And okay, so we’re involved with a company that has legal issues, that’s a meaningful piece of… And so you can really use the numbers to make it sing.

But the reality is, a business is an operating entity that are run by human beings. And the real work that determines the outcome is what’s going to happen in the future, not what’s happened in the past. And so you’ve really got to get down into the details of if it’s going to grow and does it have a competitive advantage and how is that valued out in the marketplace?