Checking Out the Income Statement

Checking Out the Income Statement

The income statement is where a company periodically reports its revenues,
costs, and net earnings or profit. It’s basically a snapshot of how much a
company is earning from its operations and any extraordinary earnings that
may have impacted its bottom line during a specific period of time. From the
income statement, you’ll be able to determine the impact of taxes, interest,
and depreciation on a company’s earnings and to forecast earnings potential.
Every income statement has three key sections: revenue, expenses, and
income. The revenue section includes all money taken into the company by
selling its products or services minus any costs directly related to the sale
of those products or services (called cost of goods sold). The expenses
section includes all operating expenses for the company not directly related
to sales, as well as expenses for depreciation (writing off the use of equipment
and buildings — tangible assets), amortization (writing off the use of patents,
copyrights, and other intellectual property or intangible assets such as
goodwill), taxes, and interest.


The income section includes various calculations of income. Usually you’ll
find one calculation that shows income after operating expenses and before
interest, taxes, depreciation, and amortization, called EBITDA. This will be
followed by net income, which is the bottom line showing how much a
company earned after all its costs and expenses were deducted. Public
companies must file financial reports with the OSC and the SEC on a quarterly
and annual basis. You can read any public company’s financial reports at Canada’s System for Electronic Document Analysis and Retrieval (SEDAR)
(www.sedar.com) and at the EDGAR Web site (www.sec.gov/edgar.
shtml) for American issuers.

A year’s worth of figures won’t show you much, so you need to look at the
trends throughout a number of years to be able to forecast growth potential
or assess how well a company is doing compared with its competitors. We
discuss a number of good sources for finding fundamental information in



Both quarterly and annual reports are important. Comparing a company’s
results on a quarter-to-quarter basis gives the trader an idea of how well the
company is meeting analysts’ expectations as well as the company’s projections.
Also, looking at, for example, results for the first quarter of 2008 versus the
first quarter of 2009 you can see whether a company’s earnings are increasing
or decreasing in a similar market environment. While for some types of
companies the first quarter is generally productive, other types of companies,
such as retail stores, are dependent mostly on fourth-quarter holiday results,
so you need to know what is expected in earnings for the various quarters.
Quarterly results allow you to monitor results from similar time periods.
Annual statements give you a summary for the year. You can also compare
current-year results to the results over a number of years to see at what rate
the company is growing.

Revenues

The first line of any income statement includes the company’s sales revenues.
This number reflects all the sales that have been generated by the company
before any costs are subtracted. Rather than go to all the trouble of showing
their math — gross sales — any sales discounts, adjustments for returns, or
other allowances = net sales. Most companies show only net sales on their
income statements. From these figures, you want to see obvious signs of
steady growth in revenues. A decrease in revenues from year to year is a
red flag that indicates problems — it’s probably not a good potential trading
choice unless you’re considering shorting the stock.

Market Behaviour : Business activity

Market Behaviour : Business activity

A number of key economic indicators can give you a good idea of what business
is doing and how that information may impact the stock markets. Key
business indicators to watch include:-


✓ The Ivey Purchasing Managers Index: This index, sponsored by the
Richard Ivey School of Business (University of Western Ontario) and the
Purchasing Management Association of Canada (PMAC), shows monthto-
month variation in economic activity.

The Ivey Purchasing Managers Index measures monthly changes in
purchases as indicated by a panel of purchasing managers from across
Canada. The 175 participants have been selected geographically and by
sector to match the Canadian economy as a whole. The index includes
both the public and private sectors. Index panel members indicate
whether activity is higher than, the same as, or lower than the previous
month across five categories: purchases, employment, inventories, supplier
deliveries, and prices. The index is released at 10 a.m. ET on the
third or fourth working day of each month at http://iveypmi.uwo.ca.



✓ The American Purchasing Managers Index (PMI): One of the first economic
indicators released each month is the American Manufacturing
Report on Business, which surveys purchasing managers and provides
reviews of new orders, production, deliveries, and inventories. This
report is released at 10 a.m. ET the first business day of each month
and reflects data compiled from the previous month. You can track this
report online at the Institute for Supply Management www.ism.ws.



✓ Durable Goods Orders: The American Commerce Department releases
another critical economic indicator of business activity in the area of
Durable Goods Orders. This indicator measures the dollar volume of
orders, shipments, and unfilled orders of durable goods, or types of merchandise
that have a life span of three years or more. This report serves
as a leading indicator of manufacturing activity and can move the stock
market, especially when its numbers vary from expectations. You can track
the Durable Goods Orders online at www.census.gov/indicator/www/
m3/index.html.




✓ The Building Permits Survey for Canada: This survey covers 2,400
municipalities representing 95 percent of the population. It provides an
early indication of building activity. In addition to data on the number
and value of building permits issued by Canadian municipalities, this
publication provides information on the average value of dwellings, the
number and value of mobile homes, and permits issued for building
renovation. The value of planned construction activities shown in this
release excludes engineering projects (such as waterworks, sewers, or culverts) and land. The Building Permits Survey is released by Statistics
Canada on the fourth business day of each month at 8:30 a.m. ET and
can be found at www.statcan.gc.ca.



✓ Housing Starts and Building Permits: The American report is another
that’s released by the Commerce Department. It can be a leading indicator
of the direction the economy will take. When the number of permits
rises, a positive economic indicator results. About 25 percent of investment
dollars are plowed into housing starts, and that makes up about 5
percent of the overall economy. The report is broken down by regions —
Northeast, Midwest, South, and West — so you can also get a strong
indication of the strength of the economy on a regional basis. You can
track this indicator online at www.census.gov/const/www/C40/
table2.html.



✓ Manufacturing Surveys: The Canadian Monthly Survey of Manufacturing
covers 21 industry groups that produce goods for both industrial
and consumer use. The manufacturing sector’s activity is monitored
monthly and annually, as it accounts for a large part of Canada’s gross
domestic product. It’s released by Statistics Canada around the 16th of
each month at 8:30 a.m. ET and can be found at www.statcan.gc.ca.
Each Federal Reserve Bank district in the United States compiles data
from regional manufacturing surveys that can help you find a score of
indicators including new orders, production, employment, inventories,
delivery times, prices, and export and import orders. Positive reports
indicate an expanding economy. Negative reports indicate a contracting
economy. The two most closely watched are the Philadelphia survey at
www.phil.frb.org/econ/bos/bosschedule.html and the Chicago
survey at www.chicagofed.org/economic_research_and_data/
cfmmi.cfm. If you’re trading in regional stocks, following the manufacturing
surveys from the Federal Reserve Banks in key regions that
you follow can help you determine the direction of the economy for the
areas most relevant to the stocks you’re trading.

Observing Market Behaviour : Jobless claims

Observing Market Behaviour : Jobless claims

The Labour Force Survey, another report from Statistics Canada (www.
statscan.gc.ca), is one of the most important leading indicators to watch.
This report is the first critical economic indicator released every month
and frequently sets the expectations for the rest of the month’s reports. For
example, signs of a weak labour market reported in the Labour Force Survey
usually are a strong indication of poor retail sales and other possible negative
reports later in the month.

The summary also breaks down data by
industry, such as construction and manufacturing. For example, a significant
drop in employment numbers for the construction sector is a strong sign that
the housing starts report also will be negative.

This report can send shockwaves through the financial markets, especially
if the numbers that are released vary greatly from expectations. Stock prices
often fall whenever the report doesn’t meet expectations or employment statistics
show signs of weakness. On the other hand, stock prices can rise dramatically
whenever the report indicates better than expected numbers. As
is true with any shock to the market, changes in prices are temporary unless
other indicators also exhibit the same trend or tendency.


The employment report can drive markets so strongly because its data are
only a few days old. Because it is so timely, this report is widely recognized as
the best indicator of unemployment and wage pressure. Rising unemployment
can be an early sign of recession, while increased pressure on wages can be an
early sign of inflation. The report also is a broad-based snapshot of the entire
labour market, covering 50,000 Canadian households and every major industry.
Statistics Canada releases the report at 8:30 a.m. ET on the first Friday of
each month with data for the previous month. The two key parts of the
report that traders need to watch are :-

✓ Unemployment and new jobs created
✓ Average weekly hours worked and average earnings
In the United States, the Bureau of Labor Statistics (BLS) (www.bls.gov)
produces the quaintly named Employment Situation Summary.


Another employment indicator traders like to watch is the Employment
Cost Index (ECI). It’s especially relevant during actual times of inflation or
when fear exists that an inflationary period may be imminent. The ECI is a
quarterly survey of employer payrolls that tracks movement in the cost of
labour, including wages, benefits, and bonuses. Wages and benefits make up
75 percent of the index. The BLS surveys more than 3,000 private-sector firms
and 500 local governments in the United States to develop the index. The ECI,
which reports data from the previous quarter, is released on the last business
day in January, April, July, and October.

Observing Market Behaviour : Money supply

Observing Market Behaviour : Money supply

The money supply is a key number to watch, because growth in money
supply can be a leading indicator of inflation in situations when the money
supply is greater than the supply of goods. When more money than goods is
around, prices are likely to rise. Commodities and money traders will want to
keep close watch over these three aggregates — money supply, inflation, and
goods and services.


The Bank of Canada and the Fed track two monetary aggregates: M1 and
M2. M1 includes money used for payments, such as currency in circulation
plus chequing accounts in banks, trust companies, credit unions, and caisses
populaires. The Canadian monetary aggregates can be tracked at www.


bankofcanada.ca (see Weekly Financial Statistics) and at www.statcan.
gc.ca (see Economic and Financial Data). Currency sitting in bank vaults
and bank deposits at the central banks are not part of M1, but instead are
part of the monetary base. M2 includes M1 money plus retail nontransaction
deposits, which is money sitting in retail savings accounts and money market
accounts. You can follow the American money stock measures for M1 and M2
at www.federalreserve.gov/releases/h6/Current. When you total
the money base, M1 and M2, you can track the total amount of money sitting
in someone’s account or circulating in the economy.


The Bank of Canada attempts to manage money growth through short-term
interest rates, or through the reserves provided to deposit-taking institutions.
When short-term rates change, they affect mortgage and lending
rates at banks and credit unions. When interest rates rise, consumers and
businesses pay off existing loans. The result is slow growth of M1+ and
other monetary aggregates. The BoC monitors several indicators to achieve
its inflation target. The growth of M1+ provides useful information on the
future economy and is a leading indicator of the rate of inflation. The Bank
of Canada’s monetary policy supports a level of spending on goods and services
consistent with keeping inflation within its target range. By monitoring
the supply of money and credit, the BoC ensures that total spending in the
economy is consistent with controlling inflation.


The Fed decided in July 2000 that it no longer would set target ranges for growth
rates of the monetary aggregates. In the late 1970s, money supply drove the
Fed’s decision-making process. As money supply grew to what was considered
out of hand, the Fed kept raising interest rates until they were so high that many
believe the Fed’s moves actually caused the recession in the early 1980s. After
that time, managing interest rates became a higher priority than managing
money aggregates. The Fed didn’t kill the idea of target ranges for the money
supply until it was certain that managing interest rates alone would help stem
inflation. Now that the Fed has proved interest-rate management works, it
decided it no longer needed to set a target for monetary aggregates.

Understanding Economic Indicators

Understanding Economic Indicators

The key to knowing where, as a trader, you are during the business cycle
is watching the economic indicators. Every day you open your newspaper,
you see at least one story about how the economy is doing based on various
economic indicators. Popular indicators track employment, money supply,
interest rates, housing starts, housing sales, production levels, purchasing
statistics, consumer confidence, shipping, and many other factors that indicate
how the economy is doing.


Economic indicators are useful to your trading. Some are definitely more
useful than others. We don’t have the space here to describe each of the indicators;
instead, we focus on the ones that can provide you with the most help
in making your trading decisions.

BoC and Fed watch: Understanding how interest rates affect markets

Watching the Governor of the Bank of Canada and the Federal Open Market
Committee (FOMC) of the Federal Reserve (which includes the seven members
of the Board of Governors, the president of the New York Federal
Reserve Bank, and presidents of 4 of the other 11 Federal Reserve Banks) and
tracking what it may or may not do to interest rates is almost a daily spectator
sport in the business press. Although members of the FOMC meet only
eight times per year, discussions about whether the Bank of Canada and the
Federal Reserve will raise or lower interest rates serves as fodder for stories
published on at least a weekly, if not daily, basis. Every time BoC Governor
Mark Carney or Fed Chairman Ben Bernanke speaks, people look for indications
of what the BoC or the Fed may be thinking. Speeches by other members
of the BoC staff or the Fed likewise are carefully dissected between
FOMC meetings. Most press coverage will shortcut all this by saying the BoC
or the Fed may raise or lower interest rates.


The Canadian and U.S. economies tend to move in lock step, so the perception
is for monetary policy in both countries to go in the same direction.
However, that has been less true since late 2000, when the Bank of Canada
established eight pre-set dates per year to announce its key interest rate
policy. This schedule is referred to as the BoC’s fixed announcement dates,
or fixed dates. In setting interest rates, Canada has recently tended to focus
more closely on the inflation rate than the United States, which tends to be
concerned with employment.

Because the Canadian economy is inextricably linked with the U.S., our
manufacturing costs and output are structured around a Canadian dollar
valued at a discount against the U.S. currency. The Canadian dollar is often perceived as a petro-currency by international investors: it fluctuates with oil and gas commodity prices. When the interest rate policy also starts to attract investors to Canada, the effect of a strong loonie is a struggle for our exporters.

Higher interest rates and high energy prices causing a high currency
exchange rate further increase the cost of our exports.
Therefore, Canadian interest rate policy is crafted with an eye to U.S. rate
policy. Canada must be aware of U.S. interest rates in order to stay competitive
with the potential of expanding exports to the United States. So that we
are not totally dependent on our southern neighbour, we undertake regular
trade missions to the growing markets across the Pacific.


The key reason for you to be concerned is that a change in interest rates can
have a major impact on the economy and thus on how you make trades. An
increase in rates is likely to slow down spending, which can lead to an overall
economic slowdown. For the most part, when the BoC or the Fed raises interest
rates, it’s because the board believes the economy is overheated, which
can fuel the risk of inflation. An increase in interest rates can reduce spending
and thus ease overheating. If, on the other hand, the BoC or the Fed fears an
economic downturn or is trying to fuel growth during a recession, the board
frequently decides to cut interest rates to spur spending and growth.


The Bank of Canada’s policies and strategies can be gleaned from its quarterly
Monetary Policy Report. The current economic state of the nation and
implications for inflation are covered at length. The information at www.
bankofcanada.ca dates back to 1995.
Speeches by the BoC Governor and Deputy Governor are also listed at this
informative Web site. The speeches often are made at the press conferences
that accompany the Monetary Policy Report or an opening statement to a
Standing Committee of the Senate or House of Commons.


For the American perspective, you can get a good hint about what the Fed
is thinking by reading the Beige Book, which is a report compiled by the 12
federal reserve banks. Summaries about current economic conditions in
each of the 12 districts are circulated to Federal Reserve Board members two
weeks prior to the FOMC meeting, at which monetary policy, including interest
rates, is set. The summaries are developed through interviews with key
business leaders, economists, market experts, and others familiar with each
individual district. You can read the Beige Book online at www.federal
reserve.gov/FOMC/BeigeBook/2008/. Find out about past FOMC statements
at www.federalreserve.gov/fomc. These links give you access not
only to current issues of the Beige Book and FOMC statements but also to
information from those two sources dating back as far as 1996. They can provide
an excellent overview of economic trends and possible shifts in Federal
Reserve monetary policy.