How to Analyze a Company: Five Numbers in Ten Minutes

If you want to know how to analyze a company without a finance degree, start with five numbers: revenue growth, margins, cash flow, debt and valuation. Read in that order, over the last three to five years, they tell you in about ten minutes what kind of business you actually own. The goal is not to predict the share price. It is to understand the business behind it.

This matters most for the part of a portfolio where investors put their own ideas. For many people, those ideas are individual companies, and the first step is knowing what the company really does with your money.

How to analyze a company in ten minutes: the five numbers

Work through these questions one at a time:

• Growth: Is revenue rising, and how fast, over several years? One strong quarter says little. A steady multi-year pattern says much more.
• Margins: How much of each dollar of sales is left as profit? The operating margin is the usual measure.
• Cash flow: Does that profit actually turn into cash, or does it disappear into new investments and unpaid customer bills (receivables)? Free cash flow is the number to check.
• Debt: Could one bad year put the company in danger? Compare debt with the profit the business earns.
• Valuation: What are you paying for all of the above?

The numbers are not hard to find. Every listed company publishes revenue, margins, cash flow and debt in its annual report and on its investor relations page, and financial data websites summarise them. Look at the last three to five years, not just the latest quarter, and never just the latest headline.

Valuation: why a great company can be a bad investment

Valuation is where many investors go wrong. An excellent business can still be a poor investment if the price is too high. Two measures help:

• Price-to-earnings ratio (P/E): How many years of current profit you pay for. A P/E of 30 means paying 30 years of today's earnings.
• Free cash flow yield: How much cash the business produces for each dollar of share price.

A high valuation means a lot of optimism is already built into the price. The company then has to keep delivering, and there is less room for disappointment if growth slows.

Same story, different businesses: two fictional companies

The course illustrates this with two fictional companies. Both grow revenue 15% a year, and both come with an exciting story. Underneath, they look like this:

*Fictional example for illustration only, not investment advice.*

Company A keeps 25 cents of profit from every dollar of sales, generates growing cash and owes nothing. Company B keeps 3 cents, burns cash, owes five times its annual profit and trades at 80 times earnings. In other words, buyers of B are paying for 80 years of current profit, compared with 30 for A.

The headline growth rate is identical. The businesses are completely different. A quick look at five numbers reveals what the story alone hides.

Red flags that say walk away, or size very small

Some warning signs suggest either staying away or keeping the position very small.

In the numbers:

• Growth bought with ever more debt
• Profits that never turn into cash
• A steady stream of new shares that dilutes existing owners

In the story:

• Claims that "this time is different"
• A valuation explained only by hope
• A business model you cannot explain in one sentence

The last point is the most important. If you cannot say how a company makes money, the numbers are unlikely to rescue the idea.

Reading a business is not timing its share price

One caution: knowing a business well does not tell you when its share price will fall. Excellent companies such as Amazon and Nvidia have fallen more than 80% at times, with declines in the 80–90% range. A drawdown of that size can happen to a strong business, not only a weak one.

Analysis tells you what you own. How much a single stock can hurt you is decided by its size in your portfolio and by the rules you set in advance. That is why many investors keep individual companies as a smaller satellite next to a broadly diversified core, rather than making them the foundation.

What to do with this

• Pick one company you own or are interested in and set a ten-minute timer.
• Write down its revenue growth, operating margin, free cash flow, debt and price-to-earnings ratio, using the last three to five years of the annual report or investor page.
• Write one sentence on how the company makes money. If that sentence will not come, treat it as your answer.
• Check the list of red flags above and note any that apply.
• Compare the position's size with the losses the lesson describes: consider what a fall of 80% in that one stock would mean for your total portfolio.

This article is based on Lesson 8.1 of our course Mastering Investments, where Module 1 is free.

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