What should I look at in the Income Statement?

24 Feb 2023

The famous value investor, Mohnish Pabrai, said in one of his lectures that when he visited Warren Buffett, he noticed a huge handbook with the financial statements of thousands of public companies. It's a very dull reading, isn't it? Indeed, if you focus on every statement item - you'll waste a lot of time and sooner or later fall asleep. However, if you look at the large volumes of information from the perspective of an intelligent investor, you can find great interest in the process. It is wise to identify for yourself the most important statement items and monitor them in retrospect (from quarter to quarter).

In previous posts, we've broken down the major items on the Income statement and the EPS metric:
Part 1: The Income statement: the place where profit lives
Part 2: My precious-s-s-s EPS

Let's now highlight the items that interest me first. These are:

- Total revenue
The growth of revenue shows that the company is doing a good job of marketing the product, it is in high demand, and the business is increasing its scale.

- Gross profit
This profit is identical to the concept of margin. Therefore, an increase in gross profit indicates an increase in the margin of the business, i.e. its profitability.

- Operating expenses
This item is a good demonstration of how the management team is dealing with cost reductions. If operating expenses are relatively low and decreasing while revenue is increasing, that's terrific work by management, and you can give it top marks.

- Interest expense
Interest on debts should not consume a company's profits, otherwise, it will not work for the shareholders, but for the banks. Therefore, this item should also be closely monitored.

- Net income
It's simple here. If a company does not make a profit for its shareholders, they will dump its shares*.
*Now, of course, you can dispute with me and give the example of, let's say, Tesla shares. There was a time when they were rising, even when the company was making losses. Indeed, Elon Musk's charisma and grand plans did the trick - investors bought the company's stock at any price. You could say that our partner Mr. Market was truly crazy at the time. I'm sure you can find quite a few such examples. All such cases exist because investors believe in future profits and don't see current ones. However, it is important to remember that sooner or later Mr. Market sobers up, the hype around the company goes away, and its losses stay with you.

- EPS Diluted
You could say it's the money the company earns per common share.

So, I'm finishing up a series of posts related to the Income statement. This statement shows how much the company earns and how much it spends over a period (quarter or year). We've also identified the items that you should definitely watch out for in this report.

That's all for today. In the next post, we will break down the last of the three financial statements of a public company - the Cash Flow Statement.

Goodbye and see you later!