Wondering if conducting financial analysis is worth your time? While the answer to this question is rather straight forward, do you or don’t you want to make money off of your investments? If you do, financial analysis can be an essential component of any investing strategy. It will afford you with deep insights into the workings of any company. This in turn will help you predict the future of the company itself.
Financial analysis refers to analyzing the balance sheets and financial statements of a company. Companies are required to keep close track of all of their financial transactions, assets, profits, losses, and everything else. In a very real sense, the financial record of a company is the most detailed and likely objective account of a company and its situation.
Even for investment strategies that don’t focus on the inner workings of a company, financial analysis can be very important. Let’s take a look at technical analysis to learn how financial analysis can help out with this investment strategy.
Financial analysis and technical analysis
Technical analysis is a type of trading strategy that focuses on price movements instead of the actual company itself. Many traders like to think that using technical analysis means that there’s no need to get involved in financial analysis. The truth, however, is more complex.
When using technical analysis, you need to pay attention to market trends. For example, a stock’s price might start to plummet. So your technical indicators might be telling you to buy, buy, buy. But wait! Before you pull the trigger it’s a good idea to step back and ask what’s going on?
Conducting a quick financial analysis on the spot, for example, might reveal that there are some serious discrepancies on the company’s balance sheet. By conducting the analysis, you see that the slide might be far from over, no matter what your technical indicators say.
It is true, however, that with technical analysis you will have to spend less of your time focusing on the financials and other specifics from companies. Still, information is power so the more you learn in any given situation, the better off you are. So no matter your strategy and no matter what stocks you are looking at, you should account for financial analysis to one extent or another.
Limits of financial analysis
Financial analysis is best at telling you about a company’s past, not its future. Financial analysis can show you how well the company has been investing its money, how efficient it operates, past profit margins, and numerous other important insights.
It cannot, however, tell you about future products, management styles, and numerous other important factors. At best, financial statements can tell you about how much a company is investing in R&D and how good management is at managing money.
Financial analysis is not an easy task either, and it’s easy to get your analysis wrong. Even something as simple as overlooking a decimal point or adding up a number wrong can ruin your analysis. And you might never even know! At the same time, you need to have a solid grasp of financial terms as there are a ton of them. While many might seem similar, the subtle differences can be huge.
You should view financial analysis as one of the many tools that savvy investors use to analyze stocks. However it is not the only tool. Such analysis can be an important part of any holistic investment strategy. However, it could be dangerous to become overly reliant on it. So if you decide to use financial analysis, make sure you keep all of its limits in mind.
Either way, it’s a good idea to take a close and long look at a company’s balance sheets, profit margins, and other financial statements.