Balloons, Beats, and Balance Sheets: Understanding Business Numbers Through a Party Lens
A Lively Guide to the Core Financial Aspects of Stocks, Companies and Their Stages
Hey there!
I’m pumped to be on your screen again. Last week, we covered business stages. This week we're about to dive into the world of numbers in a way that's as fun and enjoyable as a party! We'll be exploring the five crucial financial elements that represent different aspects of a business.
If you’re new here, welcome aboard!
I’m Michael, your friendly stock guy, and I’m on a mission to make stock evaluation as easy as choosing your favorite ice cream.
Last year, I embarked on a wild journey to create a program that does the heavy lifting when it comes to stocks. Curious about my wild escapades? Read the full story here.
The party-themed rundown of our fabulous five
By understanding these five financial numbers, you'll gain insights into the different stages a company goes through and why famous investors like Warren Buffet and Peter Lynch love stage 4 and 5 companies.
1. Revenue: Think of revenue as the total income generated by throwing a party – from ticket sales, VIP access, drinks, and merchandise. It's the life of the party and keeps the music buzzing.
2. Gross Profit: Gross profit is what's left after paying the direct costs (food, drinks, decorations) from the revenue. It's like knowing how much money you have left for remaining party expenses. Gross Profit = Revenue - Direct Costs
3. Operating Profit: This is the money that remains after covering both direct and indirect costs (venue rental, marketing, DJ fees, staff wages). It's a measure of how successful the party was in terms of generating income. Operating Profit = Gross Profit - Operating Expenses
4. Net Profit: The final amount left after paying all expenses, including taxes and other non-operating expenses. This is the ultimate measure of a party's financial success – the cherry on top of the cake! Net Profit = Operating Profit - Taxes - Non-operating Expenses
5. Share Count: Imagine organizing the party with a couple of friends. After the hangover is gone it’s time to divide the net profit cake among them. Each person's share represents their portion of the total profit generated. Why? Because usually you never party alone.
Now that you've met our fabulous five, let's look at how they perform at different company stages.
Here's a simplified illustration to help you visualize their roles:
Stage 4 and 5 companies are where our party plays, where stability and value come together to dance. That's why Warren Buffet and Peter Lynch can't get enough of them. This is what we are looking for. Screw stage 6 and gamble with stage 1 - 3.
(Btw, if you want to know why Warren is investing in Japanese stocks right now, read this Twitter thread.)
Why is Stage 4 and 5 so attractive?
These stages are where math plays a more significant role, but they also come with lower potential growth compared to stages 1 to 3.
Again. And sorry for saying it again. Understanding your investment personality is crucial, as it helps you navigate these stages. If a share price is twerking like crazy and it makes you sweat and stink, well you are probably invested in the wrong stage party. Go find the right one.
That's a wrap!
Congrats on making it through. And you know what?
Now you already know more than the average stock investor
Most never understand the above stuff, because they think it’s too hard.
“We have three baskets: in, out, and too tough. … We have to have a special insight, or we’ll put it in the “too tough” basket.”
― Charles T. Munger
Let me know if there's anything else you'd like to learn about.
Is this all I have to know Michael?
No, there are a bunch more.
In our next articles, we'll delve into how to evaluate stage 4 and 5 companies from a fundamental perspective.
Weekly Update
Days until the end of 2023: 251
Quote of the week
The middle part is the boring part.
Statistic of the week
Get this.
90% of blogs or podcasts don’t make more than 3 content pieces.
Only 10% get past 20. So only 16 to go and I’m in the 10% 😊
I got these numbers from this brilliant video. Love it.
Progress:
· Developed a function to calculate company stability and it can be configured with an external file. Feels so “next level” for me. Experienced coders will probably grin now.
· Completed my AI homework - yeah
· Generated a report on average dividend payout ratios per industry (available here)
· Learned more about how you can use statistics to differentiate between stationary (more predictable) and non-stationary (less predictable) data.
Plans:
· Go on a short trip to Croatia with my sister
· Research some AI basics
· Calculate some thresholds
· Write the next article
Where is my head?
It’s exciting that there is so much to learn. Exploring ways to how to use AI to enhance my program is mind blowing. But you have to focus on the basics to understand the stuff above. Be aware of the shinny syndrom.
That’s it.
Catch you next time!
Michael
Disclaimer:
The information in this article is my personal opinion. It is not consulting, nor does it constitute investment recommendations.
I do my research carefully and follow my personal investment strategy.
The stock market is a complex building with its own rules. They are no rules set in stone, like the rules of physics.
Therefore, use the contents of this newsletter at your own risk. Investing in the stock market can always lead to a total loss of the capital invested.