First step

Have you always wanted to know how to understand a company's annual report and financial statements? In this series of lessons, we set out to teach you how to take the financial statements of a company and carefully analyze them to determine what the stock is truly "worth". This allows you make better investing decisions by helping to avoid the costly mistake of purchasing a company when its share price is too high.

Eventually, by reading, printing, and studying these lessons, you will be able to pick up a balance sheet and truly understand what the numbers mean. At the end of each lesson there is a quiz to test your understanding of what you learned.

In this first installment, we are going to look at why the stock market exists and explain how a business goes from being a small, family-owned company to a corporation with publicly traded stock.

The stock market can be a great source of confusion for many people.

The average person generally falls into one of two categories. The first believe investing is a form of gambling; they are certain that if you invest, you will more than likely end up losing your money. Often these fears are driven by the personal experiences of family members and friends who suffered similar fates or lived through the Great Depression. These feelings are not ground in facts and are the result of personal experience. Someone who believes along this line of thinking simply does not understand what the stock market is or why it exists.

The second category consists of those who know they should invest for the long-run, but don’t know where to begin. Many feel like investing is some sort of black-magic that only a few people hold the key to. More often than not, they leave their financial decisions up to professionals, and cannot tell you why they own a particular stock or mutual fund. Their investment style is blind faith or limited to “this stock is going up. We should buy it.” This group is in far more danger than the first. They invest like the masses and then wonder why their results are mediocre (or in some cases, devastating).

In this series of lessons, I set out to prove that the average investor can evaluate the balance sheet of a company, and following a few relatively simple calculations, arrive at what they believe is the “real”, or intrinsic value of the company. This will allow a person to look at a stock and know that it is worth, for instance, $40 per share. This gives each investor the freedom to know when a security is undervalued, increasing their long-term returns substantially.

Before we examine how to value a company, it is important to understand the nature of businesses and the stock market. This is the cornerstone of learning to invest well.