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Screening a Balance Sheet to Find Undervalued Stocks

stride-practical-investing-how-to-analyse-a-balance-sheet-featured-1.jpgVideo Tutorial: Discover how to find undervalued stocks using balance sheet information and financial ratios in our latest video tutorial using STRIDE's stock screening software.

What's so important about a balance sheet? Well, it's also known as a "statement of financial position", because it reveals intimate details about a company's assets, liabilities and owners' equity (net worth). Simply put, if you're a shareholder or looking to be a shareholder, screening a balance sheet can help you understand whether or not a company is a sound long-term investment. It's fundamental to value investing. In this video tutorial, with STRIDE's stock screening software, we explore the deep analysis of a balance sheet using financial ratios like: Price to Book Value ratio, Price to True Book Value ratio, Current ratio, and  EBITDA ratio.

Video Tutorial: Analysing Balance Sheets to Find Undervalued Stocks

 
 
 
 
 
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If you'd like to learn more about screening stocks using financial ratios and balance sheet information, sign up for a free demo of STRIDE's stock screening tools below.

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The following are transcript points taken from the above video tutorial.

Discover How to Find Book Value (BV)

This is a key metric to consider when screening stocks using a company's balance sheet. Here, you’re basically looking for businesses that are trading below their net asset value. You don’t want to find anything too cheap though, because if something looks too good to be true – then it probably is. But this ratio can still be quite misleading (at least on its own), because book value is net asset value, and net asset value can incorporate goodwill and intangible assets (brand name, intellectual property, etc.). These intangible assets don’t necessarily translate into hard currency, and so when screening a company’s balance sheet, you want to try and filter them out.

Enter, True Book Value (TBV)

That’s why we have another ratio called price to true book value, which does precisely this. If there is no discrepancy between a company’s BV and TBV, then it’s starting to look like a good investment… but it does need more digging, which is why at STRIDE we took this a step further and created the ratio: Adjusted True Book Value. We use this ratio to discount the assets below the book value to get their liquidation or fire-sale value. If the ATBV doesn’t alter from the TBV, then it means the company’s assets are likely cash (a good thing), but if it does discount the TBV quite significantly then you may have something to worry about. Ultimately, you want to make sure that a company's trade value isn't riding on (mostly) intangible assets.

These 3 ratios give you a look at the asset levels in a business's balance sheet, but there are a couple of other quick screen processes you can still make use of.

Current and Quick ratios

A simple option, but an effective analysis ratio, is the current ratio (CR), which looks at your current liabilities to your current assets. You’ll want to be seeing that the company has enough current assets to set off all of its current liabilities.

Then there’s the quick ratio, which is very similar to the CR except that it includes your total receivables (money due to the business within the next year). This offers a more long-term view of a business's financial health – and a business should certainly pass this quick ratio test to be considered a sound investment.

Net Debt / (EBITDA - Capex)

The reason this ratio is helpful, is because it allows you to look at businesses who would be able to pay down their debt pile in a relatively short space of time even after paying their capital expenditures (based on the most recent year’s performance).

Total Debt to Equity

This is an interesting one that gives us the flavour of the overall financial state of the business. It makes sure the shareholder equity is a bigger stack than what’s owed to banks or creditors. Thus answering any value investor's question of "Is the financial health of the business in my, the shareholder's, favour or the creditors’ favour?" No one wants to invest in a company that's ruled by its creditors. 

And that’s why a healthy balance sheet is fundamental to a good value target. If you'd like to learn more about screening stocks using financial ratios and balance sheet information, sign up for a free demo of STRIDE's stock screening software below. 

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Topics: STRIDE, Valuation

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