375

Analysis of Financial

Statements

10

OnMay19,1999,DellComputerCorp.announcedthatitsfirstquarterearningswere

42percenthigherthanthosereportedoneyearearlier.Thisdramaticincreaseinearn-
ingswasroughlyinlinewithWallStreetprojections.Nevertheless,Dell’sstockfellnearly
$4ashareimmediatelyaftertheannouncement.
At first glance, the market’s response appears puzzling. However, analysts
zeroed in on the fact that Dell’s profit margin in the first quarter had fallen consider-
ably. In recent months the computer business had become a lot more competitive,
and this increased competition had pushed down computer prices. Dell’s earnings re-
port indicated that lower prices for consumers had lowered margins for Dell’s share-
holders.
Still, Dell stockholders have done fantastically well over the past ten years. A
$10,000 investment in Dell in early 1991 would be worth over $1 million today. So,
while Dell’s increased earnings might suggest that the stock will continue to do well,
the lower margins raised concerns that earnings growth in the years ahead might be
lower than previously expected.
Wall Street’s response to Dell’s announced earnings brings home several impor-
tant points. First, investors and others outside the company use reported earnings
and other financial statement data to determine a company’s value. Second, analysts
are primarily concerned about futureperformance—past performance is useful only
to the extent that it provides information about the company’s future. Finally, analysts
go beyond reported profits—they dig into the financial statements.
So,whilemanypeopleregardfinancialstatementsas“justaccounting,”theyare
reallymuchmore.Asyouwillseeinthischapter,thestatementsprovideawealthofinfor-
mationthatisusedbymanagers,investors,lenders,customers,suppliers,andregula-
tors.Ananalysisofitsstatementscanhighlightacompany’sstrengthsandshortcomings,
andthisinformationcanbeusedbymanagementtoimproveperformanceandbyothers
topredictfutureresults.Financialanalysiscanbeusedtopredicthowsuchstrategicdeci-
sionsasthesaleofadivision,amajormarketingprogram,orexpandingaplantarelikely
toaffectfuturefinancialperformance.

371

10