Why do stock investors read income statements of a stock before investing?
This is because stock investors want to find out the track record of a stock when it comes to making a profit. Basically, stock investors would prefer to invest into stocks that have generated consistent growth in profits as the stocks are able to pay out higher dividends to them or to reinvest their profits earned back so that the stocks can earn higher profits and become more valuable in the future.
But, I totally get it. The next question is: ‘How do I read income statements of a stock?’ The following is a snapshot of the statement of profit or loss (which also is known as income statement) of Sheng Siong Group Ltd, an operator of chains of grocery stores and supermarkets listed in Singapore.
If you are new to financial statements, you may find this overwhelming. But, do not fret. Here, I’ll share 7 major items that you need to take note of in a stock’s income statement so that you have an easier time interpreting it. As such, they are as follows:
Item 1: Revenue
This refers to sales generated by Sheng Siong from its business activities, which is the operation of grocery stores and supermarkets.
Item 2: Gross Profits
It is derived from revenues minus its cost of sales, which includes the cost of having secured supplies of its daily products such as food & beverage (F&B), toiletries, and household products from its suppliers.
Gross Profits = Revenue – Cost of Sales
Item 3: Operating Profits
It is derived from gross profits minusing off operating costs, which include costs of selling, distribution, and administration of the business operations. Also, this will include adding income which are incidental to the operation of its business, which include sales of recyclable items, foreign exchange gains, and the receipt of government grants. So, in essence,
Operating Profits = Gross Profits – Operating Expenses + Operating Income
Item 4: Profits before Tax (PBT)
It is derived from operating profits after adding non-operational income / gains and minusing off non-operating expenses. Here, in Sheng Siong’s case, its gains and expenses are its financial income and expenses incurred. This is because its finance income (interest income) received and financial expense (interest cost) incurred do not reflect the operating performance of Sheng Siong.
Here, I think it is important to take note that the reason for investing in stocks is to have a share of its profits and we want its profits to grow consistently. This is why it is important to look at Item #3 – Operating Profits first as we first want to ensure that the company can generate profits from its businesses and not to rely on non-operative gains for its earnings.
PBT = Operating Profits + Non-Operative Gains – Non-Operating Losses
Item 5: Profits After Tax (PAT)
It is derived from PBT minusing off income tax expenses.
PAT = PBT – Income Tax Expenses
Item 6: Profits Attributable to Owners of the Company
From PAT, there is a breakdown, where S$ 75,732,000 in PAT is being attributed to shareholders and S$ 23,000 in PAT belongs to non-controlling interest.
Here, the S$ 75,732,000 in PAT belongs to investors. This would be the figure to take note of. Meanwhile, what are non-controlling interests and who are they?
To understand who non-controlling interests are, there are a couple of things to know about Sheng Siong and the reporting of its financial statements. First, the stock has a number of subsidiaries as follows:
All of its subsidiaries are 100%-owned by Sheng Siong. The only exception is for Sheng Siong (China) Supermarket Co. Ltd where Sheng Siong owns 60% interest in the company.
When it comes to Sheng Siong’s group financial statement, the financial results for each subsidiary, including Sheng Siong (China) Supermarket Co. Ltd, shall be included in full as if Sheng Siong has 100% of Sheng Siong (China) Supermarket Co. Ltd, despite the fact that it owns only 60% stake in the company.
After having PAT, it then separates profits attributed to non-controlling interest, who is the 40% shareholders of Sheng Siong (China) Supermarket Co. Ltd, from profits attributed to shareholders of Sheng Siong. That amount is S$ 23,000 for financial year 2019.
Hence, in essence, non-controlling interest refers to 40% shareholders of Sheng Siong (China) Supermarket Co. Ltd.
Profits Attributable to Owners of the Company
= PAT – Profits attributable to non-controlling interest
#7: Earnings per Share (EPS)
Finally, EPS is calculated by dividing its profits attributable to owners of the company (ordinary shareholders) with its weighted average number of shares during the period. In 2019, this involves taking S$ 75,732,000 in its profits and dividing it with 1,503,537,000 shares to derive an EPS figure of 5.04 Singapore cents.
Profits Attributable to Owners of the Company /
Weighted Average Number of Shares
Subsequently, we take its EPS figures and compare it with Sheng Siong’s stock price. For instance, Sheng Siong is trading at S$ 1.55 a share and its EPS is 5.04 cents. Therefore, by dividing stock price of S$ 1.55 with EPS of 5.04 cents, it has a P/E Ratio of 30.75. This means, would you invest S$ 30.75 into Sheng Siong to earn S$ 1.00 per annum from the company?
From them, you can make a good assessment if you want to invest into it or not by yourself?
The above article is meant to introduce the basics of reading and interpreting a statement of profit or loss (income statement). Mastering the basics is helpful to stock investors as they can use the above information to identify good stocks and separate them from bad stocks that do not. So, in summary,