Stocks as a Source of Passive Income
In previous articles, we have learned about retirement planning and the general concept of stocks. Personally, I think that it is important to have a continuous source of income in order to secure a retirement plan. Investing in stocks could potentially provide us an alternative to earn passive income during our retirement days. Therefore, a profitable company, which has a strong track record in its past performance is a choice of mine to invest in. If you are not sure on how to invest, then fundamental analysis is a simple way for you to make an income generating investment.
What is Fundamental Analysis?
One of the wealthiest man in the world, Warren Buffet, is well-known for employing fundamental analysis in picking his investment. From our previous article on stocks, we have learned that owning a stock means having a share of the company. Instead of solely relying on dividend payments from the ownership of the company, you might also want to consider having capital gains from the stock that you have purchased. Warren stresses that the critical investment factor is to determine the intrinsic value of a business and pay a fair or bargain price (The Warren Buffett Way, 2005).
Fundamental analysis is a method used to measure the intrinsic value of a business by evaluating its financial statements. Intrinsic value is the actual money value that a stock possess itself, which is different from its current price. When the current price of a stock is higher than its intrinsic value, it is said that the stock is overvalued. However, when the current price is lower than its intrinsic value, the stock is being undervalued. Buffett’s strategy in stocks investment is picking those stocks which are undervalued and hold it in a long term for the stock price to rise.
An investor’s aim is to maximise the return on investment and to minimise the risk. You may not want to invest in a company which has poor performance that could not generate a sustainable income for you. Poor performances lead to a drop in investors’ confidence and might lead to selling pressures, dragging down the share price along the way. Hence, it is crucial for us to know the financial position of a company before investing in it.
Evaluation of financial statements is crucial in the usage of fundamental analysis. They are made up of an income statement, balance sheets, and statements of cash flows. The income statement reports the financial performance of a company by showing the revenue, the expenses, and the net profit from both operating and non-operating activities; The balance sheet focuses on assets, liabilities, and equity, which ultimately shows the financial position of the company; Statement of cash flows will indicate how much cash is available in the company. These statements can be found in the company’s website, under ‘Investor Relations’ column.
As fundamental analysis is performed to the whole chunk of financial report, it is impossible to go through all the details of the analysis in this article. Therefore, we will be focusing on analysing the revenue and profit in income statement in this report. Revenue and net profit of a company are both critical as they tell us:
- Growth of a Company
By comparing revenue generated during a year with revenue reported in the past, it could tell us whether the company growth is on uptrend or downtrend.
- Demand for a Company’s Products
We can tell that how popular the products of a company are by analysing the revenue. Usually demand for products are in-line with the revenue.
Profit is the earnings of a company, when the total amount of revenue exceeds the expenses, costs, and taxes. In some cases, revenues of a company are increasing, but its profits could be declining. This happens because its expenses are getting higher.
Case Study 1: HeveaBoard Bhd (KLSE:5095)
HeveaBoard Bhd. Is one of the largest particleboard producer in Malaysia. It has a track record of achieving growth in revenues, profits, and cash reserves over the past 5 years. Below figures is obtained from HeveaBoard Bhd. Annual Report 2015.
5-Year Financial Highlights
|Profit After Tax|
Figures from above show us that revenues of HeveaBoard Bhd. are on an uptrend. Although there is a slight decrease in revenue in 2012, the profit increased by 363% from RM 3.34 million to RM 15.48 million, a huge leap considering the short time span of 5 years. Besides, its profits are increasing every year since 2011, which means that the company is generating a stable income.
Stock price of Heveaboard Bhd from 2011 to 2015:
Analysing the revenue and profit is only a little part of fundamental analysis. There are many more to consider when buying a stock, such as earnings per share, P/E ratio, and other financial ratios. Stay tune with us to get to know more about investing in the stock market!
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