Analyzing Companies with Short Histories
Here at the SmallCap Informer, we adhere to the general principles of the non-profit investor education organization BetterInvesting as implemented in the Toolkit 6 software program. This is the tool we use to generate the stock study included with each company profile in the Informer.
The first page of the stock study is a view of the past 10 years of a company’s financial history, focusing on the growth of earnings per share, sales, prices, and other values. The objective here is to determine the level of consistency of past growth as well as the strength of that growth. Companies that exhibit high levels of growth in the past are more likely to continue that trend into the future, so this visual review of past results is a quick way to examine the quality of a company’s management.
For smaller or newer companies, such as those that have recently gone public, there may only be a few years of data available from a data service such as that provided by StockCentral.com or BetterInvesting. In this case, as William points out, it is more difficult to evaluate a company.
First, when reviewing companies for the SmallCap Informer, we like to see three years of operating history. This does not mean that the company has to have three years of history as a publicly traded stock, however. The key is to be able to discern some insight into the direction in which the company’s business is headed. Are revenues and earnings growing?
For companies that have begun trading shares on a public exchange in recent years, there is often financial data available for the period prior to the initial public offering. As part of the process of offering shares for sale to the public, companies must file a series of statements and documents with the Securities and Exchange Commission.
Primary among these is the S-1 Registration Statement, a comprehensive and lengthy document that details a company’s prospective uses of the capital being raised in the offering, the various risk factors involved in investing in the endeavor, the team of executives and major investors involved in the business, and much more.
Subsequent to the filing of the S-1 form, companies may provide additional or revised information in the period leading up to the IPO. These are known as S-1/A statements, and companies may file several of these amended documents during the weeks prior to the offering date. When investigating a company, the most recent S-1/A statement should always be consulted.
In the S-1 or S-1/A statement, a company will include consolidated financial statements, comprising income statements, balance sheets, and statements of cash flows, going back at least three years. Results are provide on a pro forma basis, which means that they are prepared on the assumption that the company will be changing its capital structure as proposed in the prospectus. We like to think of them as a view of the company’s results as if the company had been a public entity during the period under review.
In these financial statements, companies will report revenues, net income, income taxes or provisions for income taxes, and even earnings per share. You won’t usually find share prices, though some companies may have valued shares in their pre-public stages and included those valuations.
The key here is that the S-1 statements include additional historical data that you can enter into a spreadsheet or your Toolkit 6 software. This data can provide you with a better understanding of a company’s current condition and prospects, whether that results in red flags being raised as to the company’s strength or in greater assurance that business is on the right track.
You can search for a company’s S-1 and S-1/A statements on the SEC’s EDGAR website at www.sec.gov/edgar.
The S-1 statements include other useful information that can increase your understanding of a company’s internal workings and big-picture strategies, so don’t ignore this important and freely available research resource.