How I interpret Income Statements

Income statement of

Prysmian Group

    Income statement is one of the financial statements published by the companies. It shows company's sales and expenses or in short their performance for a specific period of time. So what is important in an income statement and what I look.


    The first record I check is the revenue. I make a comparison with the one recorded for the same period a year ago and how it performed in the last 12 months. Mostly the market has some expectations about the revenues and if the published record misses that expectation it could be taken negatively by the market and stock price may drop sometimes significantly. I always check how the revenuee are performing compared to the forecast given prior by the company. Most companies in the beginning
of the year are publishing their expectation for the year, it is important whether company's management expectation and the realizations overlap.

    Gross Profit

    For some companies which depend on a commodity for example this figure is important. I try to understand how the input materials are affecting company's earnings. You have to be able to forecast the future earnings by watching  the moves in some materials or commodities prices up and down.
    For software producing companies this figure is mostly useless. If I have to generalize, it is good for the company to have high Gross Profit and that figure not to fluctuate much YoY.
     For non-software firms Gross Margin above 40% I consider as very good. A figure below 20% is a signal that the firm has problem with competing on the market, do not have unique product and consequently no pricing power. For a software producer company Gross Margin should be at least 60%.

    Research and Development Expenses (R&D)

    I try to stay away from companies having high R&D expenses. In the software industry high R&D is inevitable, mostly this is the biggest expense record of those companies.
    For non-software companies I look for companies with below 5% R&D expenses of Gross profit.

    Amortization and Depreciation Expenses (D&A)

    Good companies have low D&A records. I try to stay away from companies having high D&A figures, such companies, to remain on the market, require huge amounts of money and in bad economic cycle their stock prices are hit very badly. Examples are Micron, Renault, etc.   

    Interest Expenses

    Good managed companies almost always have very low or no interest expenses. I know many companies with good products, high Gross and Operating margins which were killed by their interest expenses.

    Operating Profits

    I mostly use two operating profit records for companies operating on the Turkish market.

        1) Net Operating profit (NOP)
            It is equal to
                + Gross profit
                -  Sales Marketing and Distr. Expenses
                -  General and Adm. Expenses

        2) Operating profit
            It is equal to
                + Gross profit
                -  Sales Marketing and Distr. Expenses
                -  General and Adm. Expenses
                -  R&D expenses
                -  Other operating Income/Expenses

    Mostly the first record which I call NOP is better for Turkish companies, especially for those exporting products abroad. These companies have huge "other operating" income or expenses depending on the Turkish Lira's performance, this creates a lot of noise. 
    I prefer companies with at least 35% NOP Margin and 30% Operating Margin.

    Net Profit

    I look for companies with above 20% Net Profit Margin. A figure below 10% is a sign that the company operates in a very competitive sector and do not have durable competitive advantage. Also it is important for the earnings to be stable YoY.



    As a conclusion I could add that a good company for me is a business having Gross margin above 40%, Operating profit of at least 30%, Net profit margin not below 20% with low D&A and R&D Expenses. Good example is Coca Cola.

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