ACADEMY MEMBERS: How To Read Balance Sheets (7 Tips To Avoid Losses) + Homework

In recent years, it has been relatively easy to make money in the stock market. With the easy money era being over, becoming proficient in reading balance sheets is now more important than ever. 

The era of easy money is finished. If you don't adapt and learn these skills, you will get destroyed in this stock market. The stonks go up methodology is not going to work in 2023, so its time for different approach to investment.

Warren Buffet always said that investing in companies without understanding their finances is gambling, and that is not what we are trying to do here. Remember, its not a "boring" accounting document. It's your way of looking under the hood of these companies. 

Poor balance sheets will eventually result in significant stock losses for investors, its just a question of time. 

When you go to the airport to catch a flight, do you leave a bit early to leave margin of safety? why not do it within a balance sheet before investing in the business. Its common sense. 

A balance sheet provides a snapshot of a company's assets, liabilities, and capital at a specific point in time. 

It differs from income statements and cash flow statements, which cover periods of time. 

When examining a balance sheet, I want you to pay attention to these 7 elements, at no particular order:

1. Look at cash vs debt: how leveraged is the company. Does the company heavily relies on debt?
2. Look at assets vs. liabilities: how many assets vs. liabilities the company has. What type of assets? Goodwill for example if a "fake" asset that you need to ignore for this purpose. 
3. Look at current assets vs. current liabilities: look at current assets (cash, receivables, inventory) vs. current liabilities (payables, short-term debt). 
4. Look at changes: examine changes in different balance sheet items, identifying what has increased or decreased and the reasons behind these fluctuations. For example, reduction in cash. Increase in liabilities, etc.
5. Look for retained earnings, which represent cumulative profits not paid out as dividends or used for share buybacks.
6. Look at the composition of assets: cash, inventory, accounts receivable, property and mainly goodwill. Understand how these assets are are created and what purpose they serve. 
7. Calculate working capital: Calculate the company's working capital by subtracting current liabilities from current assets. Positive working capital indicates a company's ability to meet short-term obligations and invest in growth. This is a key element of the financial health of a company.

Despite the urge to focus on growth and popularity, remember: it's vital for you as good long term investors to examine the financial health of a company before you even consider investing. 

Your homework for this week is to submit a one page analysis of the balance sheet of Amazon, Palantir and Tesla, using these 7 elements I explained above. You can submit it on discord, under Tom's Academy in the "HOMEWORK" section. 

Tom