How can numbers be deceptive when analyzing 2 stocks for investment?




How can numbers be deceptive when analyzing 2 stocks for investment?

Most of the analysts commit this mistake that I am gonna be telling you about. There is one question that the analsyts forget to ask before giving one company an upper-hand over the other. See for yourself, whether you commit the same mistake or a question arises in your mind? So here it goes.

Let us say there are stocks of 2 companies, A and B. Both have been operating under a duopoly, there is a strong competion between the two companies and more often than not, both the companies have close to 50% customers in the entire market segment. Seems like both are quite similar , right? I am giving you the below numbers(imaginary) , see if you can now decide which company is better in terms of less risk for your money and more ability to raise funds and acquire the customers of the other company.

Company A - Assets: Land - 55,000 , Machinery - 40,000 , Current Assets - 15,000
                       Liabilities: Equity - 47,000 , Debt - 51,000 , Current Liabilities - 12,000

Company B - Assets: Land - 62,000, Machinery - 49,000 , Current Assets - 17,000
                      Liabilities: Equity - 66,000 , Debt - 51,000 , Current Liabilities - 11,000


Now, you have financial information of both the companies, I just made it a bit easy for you to tell, which company may be better performing or has the ability to rise above the later. Take your time, and tell me which company seems better?

Company B right? Think again, isn't there an important question you are forgetting to ask. Alright, no more suspense. What many analysts fail to ask themselves is how old is the company or when were the assets of a company purchased.

Let me make it super easy for you, Company A purchased land worth 55,000 in 2008 and company B purchased land worth 62,000 in 2016 and since book value is recorded in the accounts, even though the actual value of land may have changed, the companies are still recording the same price. The reality is that the land that company A owns is now worth 1,80,000 in 2020 and the land that company B owns is worth 78,000. Similarly, the machinery that company A owns was purchased 5 years prior to company B, so company A was able to buy more machinery for lesser price due to the inflation effect. And, more machinery means more production capacity and ability to meet the demands faster. This high production capacity was the reason company A was keeping low inventory in its stores and therefore had lower working capital (Current Assets - Current Liabilites)requirement. In this case, 3,000 vs 6,000.

Haha, I know right , isn't this fascinating how time changes the way we should be looking at things when analysing companies. So, from now on, don't just look at the numbers, look in deeper, you will know which company is better. :D

 Thanks for reading!

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Comment on any query you had like me to address.

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