hi welcome back in this session i'd like to take what we've talked about in terms of income statements and apply it with real companies to see how the numbers play out but before i do that i'd like to do a big picture perspective of what income statements look like based on where a company is in the life cycle remember companies are born just like people are they grow up they mature they decline and they go out of business so if you think about companies going through this life cycle income statements reflect the changes that companies go through early in the process what are you going to see you're going to see high revenue growth young companies because you're scaling from such a small number will have high revenue growth that revenue growth will tend to slow down as companies age and then when they go to decline revenues will shrink early on companies are going to lose money why because they're not making much in terms of revenues they have lots of expenses as they grow up and they mature those losses become profits they stabilize as a company becomes mature and as a company declines those profits decline as well if you look at a company's income statement you should be able to make a judgment as to where that company is in the life cycle though sometimes companies can reinvent themselves so let's look at four companies across the lifecycle with each of these companies rather than talk about every number in the income statement which can be overwhelming there are so many numbers i'm going to focus on a few items that i think bring home the differences across companies as well as the commonalities let's start with peloton peloton for those of you not familiar with it is a company that sells really expensive exercise bikes and treadmills and subscriptions that you get where you pay a monthly subscription every month to get out to get classes that you can take on the on that equipment this was from the peloton prospectus at the time that they went public in 2019 it is a very young company and here's how you see it manifest itself when you look at revenues notice the revenues from 2017 to 18 double and double again in 2019 why because you're growing off a relatively small number high revenue growth if you look at the gross profits they look pretty healthy even though it's a young company why because gross profits reflect just the cost of goods sold then if you go down to the net income you see the features of a young company the company is losing money then don't freak out don't say this is a terrible company it's exactly what you should expect from most young companies now one of the items that i want to draw your attention to is r d you're saying so what it's an expense it is an expense i'm just not sure it's an operating expense something we'll come back and talk about later but r d is an expense that's designed to create benefits over many years it might be a little unfair to treat it as an operating expense overall young companies high growth decent gross profits but big losses let's move one step up the ladder and look at netflix netflix has been around a while it's still a growth company but it's a much bigger growth company it too is growing just like peloton was but not at the same rate why because you're building off a bigger base in many ways the lower growth rate at netflix is even more impressive given the base from which it grows from as with peloton there is an item that's troubling technology and development for those of you familiar with netflix that technology and development is what netflix brings building its platform which is where it makes its money in the long term it's treated as an operating expense now once you look at the net income that net income now is positive why because the company is beyond the young growth phase it's a mature growth company at the bottom of the income statement you see two items basic and deluded you're saying what are those basic takes the net income and divides by the actual number of shares outstanding what is diluted do it takes the same net income and divides but the shares that could potentially be outstanding if options and restricted stocks that are not counted are counted in as part of shares so basically a fairly conventional income statement before i leave the netflix income statement though if you go towards the bottom of the statement you notice that the net income is adjusted for items that are viewed as non basically extraordinary items one of those items shows up every year it's the income or loss from foreign currency translations you're saying what is that netflix is foreign operations to the degree that the dollar gets stronger or weaker over a period its income in a foreign currency can go up or down this is not an extraordinary item given that netflix is a global company this is going to shock you saying how do you know well it shows up every year and the signs change sometimes it's positive sometimes it's negative in contrast though the second item which change and again shows up in only one year 2017. so if you're thinking about extraordinary items the change in unrealized game that one time item that shows up in only one of the three years has a much better argument for being treated as an extraordinary item that foreign currency losses are gates let's move one step further up the ladder and look at coca-cola once upon a time this was a great growth company those days are now behind it at best it's a mature company and you can see that reflected in the revenue growth that is fairly low in fact if you look at the 2017 to 2019 revenues revenues barely change if you look at the the expenses the biggest expense is sgna in fact if you contrast the two expenses cost of goods sold in sdna notice that sdna is almost as big as cost of goods sold i didn't draw your attention this but if you go back and look at both peloton and netflix you'll notice that their cost of goods sold are much higher as at least relative to revenues and coca-cola now if you're wondering why the answer is very simple coca-cola's cost to goods sold is small the syrup the bottling if they in fact if they own the bottling plants much of the cost is in the form of marketing its biggest asset its brand name if to build that brand name you're going to spend on advertising if you go further down the income statement you'll see an item that says equity income or loss what is that that reflects the income or loss that coca-cola makes in the subsidiaries the holdings it has in other companies so those are three items and you can already see as you went from peloton to netflix to coca-cola the transitions in growth and the transitions in profitability peloton lost money netflix makes money coca-cola makes even more money now if you look at coca-cola's footnotes there's additional information that might or might not be useful when you do financial analysis coca-cola is a multinational company so it does break its revenues down by region so i found this in the footnotes and i'm troubled by one aspect of coca-cola's breakdown if you look at the breakdown geographically first it's into four regions europe middle east and africa already saying why would you bundle africa with europe but seems to be something companies often do latin america north america and asia pacific okay your geographical breakdown might not be the one that i chose but remember you don't pick this the company does what troubles me though is in this breakdown there's a breakdown for global ventures and bottling investments which are not geographical breakdowns they're business breakdowns some companies seem to want to do this and it is in fact troubling from a financial analysis perspective to kind of meld together geographical and business breakdowns there's an item also called corporate you're going to see this anytime companies break revenues down what are corporate expenses these are expensive in search of a revenue source they're the expenses of headquarters they don't go to any particular geographical area and they apply to the company now the the final company i want to look at in this in across this lifecycle is storage now turret is an old company in fact you can argue that traditional automobile companies are in decline now beset by green energy electric car companies you see the numbers for 2019 and 2020. why do i call toward a company in decline well look at the revenues in 2020 they're actually lower than they were in 2019. okay you'll also notice something interesting in this in this income statement there is a financing operation revenue in a cost to financing operations what is this every automobile company or most of them have a financing business embedded a bank embedded in the middle of a company what does this bank do it's a captive bank it's actually a financing operation to allow people to buy toyotas it's already a little messy because when you put in a bank in the middle of a traditional company you you you make it a tangled web to untangle but that's why you see financing operations here if you go further down just like with coca-cola you see foreign exchange gains and losses basically move from positive to negative to negative now equity and income and affiliated that's those are the cross-holding so toyota you can see if you look at the life cycle is a company more on the verge of decline than growth with a financing business embedding it clearly a multinational with holdings in other companies now as you look across sectors the first thing you have to remember is the accounting rules at least the principles that govern accounting don't vary across sectors but when you look at individual sectors there will be line items that are specific to that sector and as you get more comfortable with companies than collector you will be able to make sense of those line items i'm going to focus on three sectors where you might run into line items that are unique to that sector the first is the commodity business where the ups and downs in commodity prices can cause line items to show up in the income statement that you don't see in other businesses the second is financial service companies and financial service companies are a very different beast than everything else you look at i mean the very notion of that i'm going to argue can be challenged a financial service company which makes it difficult to read an income statement for a bank the same way you read it for other companies and the final one is pharmaceuticals so with no further ado let me look at a commodity company this is total a french oil company again one of the points i want to make is hey accounting just because european companies follow ifrs and u.s companies follow gap doesn't mean you can't compare across companies they have a lot in common if you look at total's income statement here's what you're going to see the first is the line the first line item you see subtracted from revenues is excise taxes why because with oil companies a big chunk of their expenses the taxes they have to pay the countries from which they extract all the governments of those countries second is exploration costs remember i made a big deal about r d expenses for peloton and technology and content for netflix arguing that maybe these expenses are really not operating expenses well oil companies have an analogous expense it's exploration cost this is the cost for exploring for oil clearly you're not doing it to get revenues this year but its treatment is operating expense the third item you will notice is non-controlling interest you're saying what is that this is another name for equity and cross-holdings now you might say why don't companies call it the same thing well get used to it companies often will use different terms for the same thing you just have to be a little creative and willing to move along with them so that's an oil company and you will notice that the expenses here the exploration costs the excise taxes specific to the oil sector and you should expect to see them for most all companies now total does break their revenues down by business but the way they break down businesses will not make sense unless you think about how the oil companies structure the all kind of business the oil business you have to extract oil first from the oil reserves then you've got to refine and make the oil suitable for people to buy so there's upstream and downstream and if you look look at the breakdown for tatar that's exactly how they've broken their business down exploration and production that in a sense is where you're going to be most affected by what happens to oil prices then there's gas renewables and power big deal for oil companies as they try to you know catch on to the new trend towards you know especially renewables and wind power refining in chemicals because many of these companies have a side product from the oil business which is the chemical business and then marketing and services and as with the coca-cola you notice there's a corporate column which basically are expenses that are that have no place to go that are separated out so business breakdown and to the extent that you can use it in financial analysis that's good to know let's talk about it back now what the first thing you will notice when you open a financial the financial statements for a bank or an insurance company investment bank is you might not see a line item called revenues because how exactly do you define revenues for a bank think of an old-fashioned bank an old-fashioned bank does it takes deposits and from customers it might pay an interest rate in the deposits and then it lends those deposits out to other people now you could call the loans revenues but that makes no sense so if you look at hsbc which is an age which is an asia based bank it's actually a multinational global bank you'll notice that its income statement starts with interest income and interest expenses which actually does make sense right interesting income is what you take in interest expenses what you pay out it also on top of it adds fee income in and fee expenses why because increasingly banks make a side and in fact many of them this is the main business of deals that they do for fees other services they provide for free there is a line item called operating income here but don't compare it to operating incomes at conventional companies why because it's after interest expenses in fact let's step back for a traditional company debt is a source of capital for banks debt is raw material in fact the notion of operating income and then subtracting financing expenses from it doesn't even make sense so here's my suggestion to you when you look at financial service companies focus on equity income income to you always has to be to the equity investors so the operating income line item i'm just going to ignore it means absolutely nothing remember we said each sector brings its own specific line items with banks when you make loans one of the things you worry about is that those loans might not be paid back so banks you'll often see a provision for bad debts or writing off loans and you see that in an item three for hsbc as provisions and set asides to cover those and there's a fourth line item which is not unique to banks but it's a line item that sometimes will show up at companies that do acquisitions now when you do acquisitions and we'll talk about this more in the context of balance sheets you create a so-called asset i'm sorry i'm saying so called because it's really not an acid it's a plug variable called goodwill now in the last 25 years accounting has moved towards a position that goodwill each year has to be revisited and impaired if there's been a problem with the company acquired where the value is dropped off and clearly seems to have happened for hsbc at least in 2019 there's a goodwill impairment it's one of the most useless items on a balance sheet because it's really not an expense it's an admission of a past failure but if you see that that's exactly what you're trying what your accountant is trying to measure final example is a pharmaceutical company in this case dr reddy's lab one thing to notice about a pharmaceutical company is its biggest expense often is a capital expense its biggest operating expense what i mean by that is r d expenses remember for peloton for netflix and even for total in the form of exploration costs with pharmaceutical companies this item becomes front and center their biggest capex is often r d and accountants treat r d badly they're treated often as an operating expense so what you see as selling and other expenses for dr reddy's that huge line-up item includes their biggest capex what does it all mean well if that r d is really capital expense the true profits for dr reddy's is much greater than what you see here because that r d expense should be written off across time we'll come back and talk more about what to do about r d and its and its separate line items but you've already seen with the with an oil company with a bank and with a pharmaceutical company that there will be items that show up specifically to that sector so here's the bottom line much is made about how accounting standards are different across the world but remember this accounting standards are converging not diverging i find it easier to compare companies today in terms of their accounting statements and 20 or 40 years ago and while revenues can take different forms the end game remains the same accountants are trying and the key word is trying to measure what these companies make as gross profit operating profit and net profit with the one caveat that with the financial service firm gross profit and operating profit mean very little you should focus on net profit so in theory at least you should be able to compare income across companies we'll talk about how to control for differences but that's at the margin i hope you found the session useful thank you very much for listening