Scrutinize and compare the company's financial reports of the past several years on the following criteria:
- Balance Sheet. The difference between current assets and current liabilities is net working capital. Dividing the long-term liabilities by stockholder's equity will give you the debt-to-equity ratio. Compare these two figures to their competitor's ratios for the same indicators. If weaker, this may indicate financial problems ahead.
- Certified public accountant or auditors report. Look out for the phrase "subject to..." as this could mean the accountant is not happy about a certain area of the company's finances. A "qualified" report like this is rare and an almost certain sign of trouble ahead.
- Footnotes, which may contain insightful information, should always be read. It gives you an idea what the company has experienced in its markets and internal finances for that year.
- If earnings are down, determine why that is from the report. If earnings are up, determine why to make sure it wasn't a once-off fluke.
- See how "exceptional items" are explained. If they are sizeable, are they temporary? Are exceptional items common in the reports? If so, this may be a warning sign if they are consistently large.
- Read the organisation or chairman's letter to the stockholders. This will tell you how the company fared. The use of words like "Except for..." and "Despite the..." could indicate problems.
- Check the stockholders' equity and the long-term debt of the company.
- Check the income statement for consistency of net sales. See if net earnings per share are almost predictable. How do both of these measures compare to the competitors?