Fundamental analysis is where you examine the actual business that you are considering buying.

After all, when you buy a stock, you are buying a small fraction of the business! You have become an owner of a company when you purchase their shares.

If you were to buy a brand new car, you would want to know details such as the size of the engine, the miles per gallon it gets, the safety ratings, customer satisfaction survey results, right? If it is a used car you would want to check for rust, whether it has been in an accident before, etc.

That is fundamental analysis.

When it comes to fundamental analysis for stock investing, you are delving into the world of accounting and finance. You are analyzing a business’s financial statements by looking at their assets, liabilities, and earnings. You are looking at their competitors and market opportunities they might have.

I love digging into a company’s financials. I have been doing this over the last twenty years. Also, for a time…way back in the day, I used to be an accountant.

If you are intimidated by these things…don’t be.

It isn’t too complicated to get what you need out of it. You can get started with a basic understanding of the major aspects of fundamental analysis and continue to learn as you go.

But in order to feel confident that you are buying a solid business, one that you can hold for at least a year or more, you will be way ahead of most everyone else who buy individual stocks on a whim, a rumor, because it is in the news, or because it is simply “going up.”

Keep in mind, I am just covering the basics here. You never stop learning, and there are a ton of books on the subject that I can recommend if you are interested in learning more.

When it comes to analyzing a company’s financial statements, know that there are 3 major financial statements

• Balance Sheet
• Income Statement
• Cash Flow Statement (for purposes of this mini-course, I’m only going to focus on the balance sheet and income statement. While cash flow is important, the major analysis lies with the balance sheet and income statement)

Let’s get started and talk about them both, along with the major things to look for in each to determine whether you are looking at a solid company that you might like to buy, or one where you should hold your nose and run as fast and far away from it as possible! 🙂

For our fundamental analysis, I am going to profile a stock that I currently own – Genasys, Inc (GNSS). I bought this stock back in August 2020 at $4.85.

The Balance Sheet

The balance sheet is a picture of a company’s assets and liabilities as of a specific date. It is is what the company has, such as cash, accounts receivable, buildings and what it owes, such as short term debt, long term debt, taxes, accounts payable. It is different than an income statement, which shows how much a company made or lost over a period of time.

What we are looking for here is stability. How “strong” is this company? Does it enough cash and other assets to overcome a difficult period, such as a recession (or perhaps something like Covid pandemic that came out of nowhere).

Another way to look at this is to think of an individual…let’s call him John.

John has not so much money in the bank, perhaps $1,000, and owns a house where he has $40,000 in equity (the house is worth more than he borrowed to buy it). He also owes $25,000 in credit card debt, owes $60,000 on a Mercedes that he bought and student loans in the amount of $20,000….one could say he is not on a very sound financial footing, right?

• His assets are: $41,000
• His liabilities are: $105,000

He owes (liabilities) exactly 2.56 times more than he has (assets).

Not only that, but the majority of his assets are tied up in a house. Brick and mortar. How quickly could he take that and spend it to pay off his liabilities?

Not so easily. It will take time to sell that house. He will have to pay a real estate agent. So we don’t just look at the ratio, we did a little deeper to get an understanding of exactly what is comprising the assets and liabilities.

We can do the same thing when it comes to analyzing a company’s balance sheet.

GNSS’s Assets:

Ok, let’s take a look at some of the basic numbers for GNSS’s balance sheet. I have taken snapshots of the key line items that I believe are most important. If you want to view the entire balance sheet info, here is a link to the GNSS Balance Sheet.

I do two major things when I look at any financial statement:

• I look at the trend of the numbers from one year to the next
• I look at the most recent year and analyze the ratios within that most recent year

Look at how assets have continued to grow in size year after year. For example, their cash in the bank (Cash & Short Term Investments) has grown year after year, from $16.4 Million in 2016 to the current $22.78 Million in 2020. That’s a 28% increase during that timeframe. You can also see that within each year, the cash assets, including the total assets, have continued to show consistent, stable growth.

I like that.

GNSS’s Liabilities:

Short term debt….uhhhh, they don’t have any. Gotta love that! This means they don’t have any loans that are due within the next year. Nothing.

Other Current Liabilities – This is what they owe and have to pay within the next year. This could be items such as a bond that is due inside of a year, or deferred revenue obligations (perhaps they got an up-front payment from a customer, but haven’t installed their system for the customer yet.) That number has grown from $2.08 Million to $9.27 Million. That is almost 450% growth.

Total Liabilities – This is the summary of everything that they owe, short term (under 1 year) and long term (over 1 year). That number has grown over the years from $2.24 Million to $11.74 Million, an increase of 524%

Now, you might be thinking, that is a startling increase in liabilities. And you are right! Their assets didn’t increase by over 500%, but their liabilities did.

However, let’s take one more step…

How does the ratio between the current assets and current liabilities look? Remember, we also need to look the numbers within a single year and create ratios for that one year.

You can see that in 2020, they had $34.04 Million of what is essentially cold hard cash that they could turn around and spend very quickly and easily and the $9.27 Million that they owe, due within the next year.

This is a ratio of 3.67. This is what is known as the “Current Ratio“.

Remember when I used that setting in my filter discussion? Anything over 1, is what I selected…meaning there is just as much current cash on hand to pay for the current liabilities. Here we have an absolutely amazing ratio of over 3.5 times! They could pay down their short-term liabilities and have a ton left over for whatever else that comes their way without blinking an eye!

Amazing.

Here is a snapshot of their TOTAL assets and liabilities. This would include their buildings, inventory, long term debt, etc…

You can see here, they have total assets in the amount of $47.12 Million and total liabilities of $11.74 Million. That is a ratio of 4. They have four times as much assets as they do liabilities.

Essentially, if you were to take this company and shut it down, you would have tons of money left over. They own way more than they owe.

Bottom line…looking at this balance sheet for GNSS, you can feel confident that the company is rock solid and can weather a downturn. Also, to grow their business, they can do this very easily and rapidly without have to issue debt or company stock because of their cash on hand.

As it turns out, this is exactly what they are doing. 🙂

The Income Statement

The income statement shows how much money a company is making (or losing) over a period of time. By breaking things down, you can get an idea of how much it costs the company to make money, to sell their products and/or services.

The income statement starts with the “top line” number, which is quite aptly named: Sales.

As you look down the income statement, you will see subtractions starting come out in successive rows until we finally reach the “bottom line” which is called “Net Income”. That is the number…after everything is taken into account, that the company earned.

Just as I did before with the balance sheet, we will be making comparisons of:

• The trend of the numbers from one year to the next
• Examine a specific year and analyze the relationships between the numbers within that year.

Below are the major items (rows) that I have extracted out of the GNSS Income Statement. If you want to view all of detail, here is a link to their full income statement.

Let’s start by looking at the numbers across the years from left to right…

Starting with the topline number: Sales

Look at that growth, year after year, going from $16.36 Million in 2016 to $43.01 Million in 2020. That is some amazing growth, isn’t it? About 260%!

Cost of Goods Sold (COGS). This is basically, how much costs to produce those sales. Think about a company that makes something (like GNSS). These are the direct costs of producing the goods sold by a company. This amount includes the cost of the materials and labor directly used to create the good. You can see that that the Cost of Goods Sold has gone up each year, from $8.61 Million in 216 to $20.37 Million in 2020. That is an increase of 236%. That makes sense, because as sales grow, the costs grow. You are selling more product.

However, notice something interesting…the COGS has grown a bit less than sales. The company has actually become a bit more effecient in selling it’s products. That is nice to see!

Let’s look at the relationship between Sales and Cost of Goods Sold.

For this, I put the numbers into a spreadsheet and calculated how much the COGS was in relation to their Sales.

For 2020, notice that their COGS was 47.36% of their sales. Their profit margin went up when compared to 2019, when COGS was 50.08% of sales. Their profit margin has widened. Overall, when I look at the year-by-year relationships, I do see some fluctuation up and down, but no cause for alarm here. If we saw that their COGS as a percentage of Sales was increasing, that would be a red flag. That would mean that it is getting harder and more expensive for them to grow their sales. You can find a ton of companies that actually have COGS that are greater than their sales! Can’t keep that up for long, right?

Here is another interesting snapshot, comparing the Sales rate of growth to the COGS rate of growth.

Notice that with the exception of 2018, the rate of Sales growth has outpaced the rate of COGS growth. This is awesome to see…it is showing that they are not struggling with increasing costs as they grow their sales. Perhaps they have been able to actually raise their prices since their products are in demand. Perhaps they have also been able to get some economies of scale, by purchasing more of the materials and parts needed to make their product at a cheaper cost.

Ok, let’s continue on and analyze our way towards the “bottom line”.

Selling General & Administrative Expense (SG&A)

Let’s quickly look at another major line-item in the Income Statement…and that is the Selling General & Administrative expense (SG&A).

SG&A is the other costs of running the business that ARE NOT directly related to producing the product or service. These are costs such as: rent, utilities, insurance payments, marketing, advertising and promotion expenses, accounting costs, legal costs, office supplies…etc.

Notice here, that those costs have gone up, but remember those top line sales numbers from before? These SG&A costs are growing at a slower pace than sales. The company is getting bigger, which is great to see, but they are expanding without blowing their budget on fancy new headquarters, for instance. This shows that management isn’t going crazy with other expenses that outpace sales or gross margin growth.

Net Income – “The Bottom Line”

Here is an extraction I made of the numbers towards the bottom of the income statement.

If you notice, from 2016, 2017 and 2018, they lost money. They lost money before they had to pay taxes…then when you factor in the taxes they had to pay, they lost even more. Those are the red numbers.

Notice that they turned profitable in 2019, with an even more profitable year in 2020.

However, look at the item I circled in blue. This is a negative number in a negative line item (taxes). So that means this was some type of tax credit.

That made their after-tax-income (Net Income Available to Common stockholders), jump from $2.78 Million to $11.87 Million. While that is great, it’s not going to be typical in years ahead. For my analysis, I would take that out. Look at the numbers above, the Pretax Income row. Here you see that they made $6.17 Million before taxes (before showing that tax credit) in 2020, compared to $3.36 Million in 2019.

This is a realistic number of their Net Income than after the tax created. And that number is rock solid, going from a bit over $3 Million to $6 Million! This number almost doubled! I would say, looking at the trends, GNSS should be firmly profitable going forward. The days of consistent losses are behind them.

Fundamental Analysis: Summary

I hope this section gave you some insight into how I break down the fundamental areas to understand how well (or poorly) a company is doing. By looking at these numbers, you are “kicking the tires”… to go back to our car analogy in the beginning.

What I covered here is very basic…there is a ton more to this, but it should give you a feel for what is involved and also allow you to use what is covered here to analyze companies that you are considering investing in.

The numbers for GNSS we looked at here are solid, in my opinion. This is why I bought shares in the company back in August 2020. The company is financially stable and growing.

Ok, onto the next section…

Part 3 – Technical Analysis

P.S. – Get Tips on the Free filtering tool I use