TradingKey – Why does a company’s stock price often swing dramatically after its financial report is released?
Because earnings reports directly reflect a company's operational health, and every figure hides market expectations about its future.
In our previous article, we explained the fundamentals of basic analysis. Now let’s explore how to assess a listed company's investment value through financial details and industry development trends.
Which key indicators should you watch?
Start with these essential metrics:
Price-to-Earnings Ratio (P/E)
P/E = Stock Price / Earnings Per Share (EPS)
When choosing stocks, have you often seen terms like “P/E of 50x” or “P/E of 8x”? This seemingly simple number reflects both the market’s “optimism” and “doubts” about a company.
For example, if a stock trades at 50 yuan per share and has an EPS of 2 yuan, its P/E ratio is 25x — meaning that if you buy this stock, you are essentially betting that “for every yuan this company earns, it’s worth 25 yuan.”
Stocks that have high P/E ratios are generally seen by the market as candidates for growth.
Take Tesla (TSLA) for instance. It's not just building cars — it's also investing heavily in innovation across autonomous driving and energy storage.
Investors are willing to pay over 100x P/E for Tesla because they're betting that Musk can turn these futuristic technologies into cash-generating machines.
On the other hand, low P/E stocks may indicate that the market expects slower profit growth ahead, or that the company's value is potentially undervalued, often labeled as “value traps” or “mature industries.”
However, this doesn't imply that stocks with low P/E ratios are always worthwhile investments.
Investors must dig deeper into a company's fundamentals to determine whether a low P/E is due to market misjudgment or if there are underlying issues within the company itself.
(Source: Freepik)
Price-to-Book Ratio (P/B)
P/B = Stock Price / Book Value Per Share
This ratio shows "how many times the current stock price is of the company's actual per-share asset value."
For example, if a listed company’s stock is trading at 300 yuan and its book value per share is 100 yuan, then the P/B ratio is 3x, which means the market values the company’s assets at three times their book value.
When P/B is greater than 1, it indicates that investors are willing to pay more than the book value for each share. Take Apple (AAPL) as an example — investors believe the brand and distribution network are worth far more than what appears on the balance sheet.
When P/B is less than 1, known as "price below book value," it may signal doubts about the quality of the company’s assets. For instance, during the downturn in the steel industry a few years ago, many steelmakers saw their P/B ratios drop to around 0.5x, as investors worried that fixed assets like blast furnaces and factories would significantly depreciate with industry contraction.
Moreover, P/B ratios can vary greatly across industries. In light asset industries such as technology and media, companies often have higher P/B ratios because their core assets — code, algorithms, and user data — are intangible and hard to capture accurately in financial statements.
In contrast, traditional manufacturing sectors like coal mining or shipbuilding tend to have lower P/B ratios — after all, equipment ages and factories depreciate over time.
Return on Equity (ROE)
This was also explained in the previous article.
How do you truly tell whether a company can "make money"? Compared to simply looking at profit figures, Return on Equity (ROE) serves more like a precise tool to measure a company’s profitability.
For example, suppose a company starts the year with 10 million yuan in net assets and ends with 12 million yuan, generating a net profit of 2 million yuan for the year.
First, calculate the average equity: (10 million + 12 million) ÷ 2 = 11 million yuan. Then divide the net profit by the average equity: 2 million ÷ 11 million = approximately 18.18%.
This number means that for every yuan of shareholder capital used, the company generated 0.18 yuan in profit.
However, be cautious — some companies boost ROE through excessive borrowing (high leverage). If market conditions worsen, the debt burden could quickly overwhelm the business.
How to Analyze a Company Through Financial Statements?
Financial statements are the digital report cards of listed companies and serve as crucial data sources for investors conducting fundamental analysis.
In this section, we will thoroughly examine how to analyze the three primary financial statements: the income statement, balance sheet, and cash flow statement.
Income Statement: A View of Profitability
When you open an income statement, the first item you should look at is not net profit — it’s revenue.
Think of revenue as the company's "appetite": the more food (income) it consumes, the more muscle (profit) it can build.
For example, Apple (AAPL) sells hundreds of millions of iPhones each year, generating over $300 billion in revenue, which gives it the resources to develop new chips and expand into new markets.
If a company's revenue has declined for three consecutive years, it's like a person who hasn’t eaten enough for a long time — even if they’re not visibly sick, they're likely malnourished. You need to ask yourself: Is the product no longer selling? Or is competition too fierce?
Next comes net profit — this is the money that ends up in shareholders’ pockets.
A high net profit indicates strong profitability and the ability to generate substantial returns for shareholders. But don’t just focus on the size of the number — also consider its quality.
Some companies inflate their net profits by selling assets or receiving government subsidies. For instance, a carmaker might sell a piece of land and make 1 billion yuan in profit.
While this looks profitable on paper, its core business could be deeply unprofitable.
When analyzing net profit, investors shouldn't only look at the absolute value, but also examine its growth trend and compare it with peers in the same industry.
A company may have high net profit, but if its growth slows or turns negative, its investment value may significantly decline.
Two important ratios help assess a company’s profitability: gross margin and net margin.
Gross Margin
Gross Margin = (Revenue - Cost of Goods Sold) / Revenue × 100%
Gross margin reflects the initial profitability of a company’s products or services and shows its ability in cost control and pricing power.
A higher gross margin means the company either produces goods or delivers services at a lower cost, or it can sell them at a premium, indicating strong market competitiveness.
For example, the material cost (such as chips and screens) of producing a smartphone might account for around 30%-40% of its selling price, resulting in a gross margin of about 60%. This means the company has sufficient room to invest in R&D and market expansion with every unit sold.
Net Margin
Net Margin = Net Profit / Revenue × 100%
Net margin takes into account all expenses and costs, reflecting the overall operational efficiency of a company.
The higher the net margin, the more revenue is being converted into actual profit after all costs are deducted — a sign of better management and operational performance.
Compared to gross margin, net margin better reflects a company's true profitability and operational effectiveness.
Take Amazon (AMZN) as an example. Its gross margin is around 50%, but its net margin is only about 10%. Why?
Amazon reinvests heavily in warehouse logistics, cloud computing R&D, and other areas. Although the net margin isn’t high, these investments lay the foundation for long-term growth.
On the flip side, if a company has a high gross margin but a low net margin, you should be cautious: Are sales expenses out of control (like overspending on ineffective advertising), or is administrative overhead too high (such as employing too many inefficient workers)?
(Source: Freepik)
Balance Sheet: Understanding Financial Structure
The basic formula for the balance sheet is: Assets = Liabilities + Equity of Shareholders.
Total Assets
Total assets represent the sum of all a company's assets, including cash, factories, patents, accounts receivable, and more.
- Current Assets: These are assets that can be quickly converted into cash, such as cash itself, marketable securities, and inventory. You can think of them as representing the company’s “checking account.”
- Non-current Assets: These include long-term assets like factories, equipment, and patents — essentially the company’s “fixed assets.” However, if an automaker’s factory is filled with outdated production lines, these assets may become a drag on efficiency.
Generally speaking, larger companies often have stronger competitive advantages in the market. They can leverage economies of scale to reduce costs and increase market share.
Total Liabilities
Liabilities fall into two categories:
- Current Liabilities refer to debts that are obligations within a year, including short-term loans and accounts payable. If a company has a high proportion of current liabilities, even a small misstep could lead to a broken cash flow chain.
- Non-current Liabilities: Long-term debts such as bonds or long-term loans, which come with lower repayment pressure and are better suited for long-term investments. For example, Tesla (TSLA) issues long-term bonds to fund the expansion of its Gigafactories. If successful, this "borrow-to-grow" strategy can significantly boost production capacity.
Important to remember: Debt-to-Asset Ratio = Total Liabilities / Total Assets × 100%.
What Indicator Reflects a Company’s Solvency?
- Current Ratio = Current Assets / Current Liabilities
A higher current ratio indicates stronger short-term solvency. However, if it’s too high, it may suggest inefficient use of capital.
- Quick Ratio = (Current Assets - Inventory) / Current Liabilities
By excluding inventory, the quick ratio gives a clearer picture of a company’s ability to meet immediate obligations.
Take a clothing company as an example: if much of its current assets are tied up in unsold inventory, the current ratio might look healthy, but the quick ratio could be very low. In the event of sudden debt demands, the company may struggle to repay.
(Source: Freepik)
Cash Flow Statement: Tracking the Flow of Cash
Why do some companies with high profits suddenly go bankrupt? The answer often lies hidden in the cash flow statement.
Compared to the numbers on the income statement, real cash movement is the ultimate indicator of a company’s health — after all, without sufficient cash flow, even the most impressive financial reports are meaningless.
The cash flow statement is primarily categorized into three sections:
1. Operating Cash Flow: The Company's "Blood-Generating Ability"
Operating cash flow refers to the cash produced from a company’s main business activities.
In simple terms, it reflects how much money the company receives from its main activities. A successful business inherently generates more cash.
- Consistently Positive = Healthy
It usually indicates that the company is operating well, its products or services are selling, and payments are being collected on time. This shows strong profitability and debt-paying ability.
- Long-Term Negative = Warning Sign
Take an electric vehicle startup with $1 billion in annual revenue as an example.
Despite high revenue, its operating cash flow remains negative because customer payments come in slowly while suppliers must be paid upfront for raw materials.
If financing channels tighten, the company could easily collapse due to a broken cash chain, which is why Warren Buffett says, “I’d rather have cash flow than an income statement.”
2. Investing Cash Flow: Bets on the Future
Investing cash flow records the money spent on buying factories, R&D, or acquiring other companies.
- Frequently Negative = Expansion Phase
Amazon invests billions every year in cloud computing (AWS) and logistics infrastructure, leading to consistently negative investing cash flow.
However, these so-called "money-burning" investments helped Amazon capture 40% of the global cloud market, becoming a key driver behind its soaring stock price.
- Sudden Positive = Caution Needed
If a company suddenly generates large inflows by selling core assets — such as its patents — the short-term financial report may look good, but this could signal desperation, like "selling blood to survive."
3. Financing Cash Flow: Borrowing and Repaying Money
Financing cash flow reflects how a company raises funds and repays debts, including issuing bonds, raising capital, and paying dividends.
- Large Positive Value = High Leverage Risk
A major real estate developer once expanded aggressively through massive dollar bond issuance, resulting in consistently positive financing cash flow.
But when interest rates rose and sales slowed, the heavy interest burden led to default, reminding investors that leveraging is a double-edged sword. Used well, it accelerates growth; used poorly, it leads directly to collapse.
- Stable Negative Value = Financial Health
Microsoft (MSFT) regularly pays dividends and buys back shares, making its financing cash flow negative. This means the company doesn’t rely on external funding and can comfortably return value to shareholders using internally generated cash.
Linking the Three Statements: Seeing the Real Picture
Looking at just one statement can be misleading. Only by combining the income statement and balance sheet can you uncover the truth:
High Profit but Weak Operating Cash Flow: Could mean excessive accounts receivable (customers not paying on time) or serious inventory buildup.
For example, a clothing brand may report profit growth, but if the cash is tied up in unsold goods, a seasonal shift could turn profits into losses overnight.
Aggressive Investment but Weak Financing: If a company keeps pouring money into new projects but struggles to raise funds, its cash reserves will quickly dry up. It's like wanting to expand your business but getting denied a loan — eventually, the project stalls.
(Source: Freepik)
How to Assess a Company’s Investment Value from an Industry Perspective?
When analyzing a company, have you ever considered whether its industry is a "golden track" or a "bloody battlefield"?
Do you know how many competitors it faces, how much room there is for market growth, or what challenges lie ahead?
Choosing the right industry is crucial!
Competitive Landscape
- Industries with Strong Market Leaders
Take the smartphone market as an example — Apple and Samsung together hold nearly 50% of the global market share.
Their dominance comes from competitive advantages, like in-house chip development and closed ecosystems.
If you're considering investing in a small or mid-sized smartphone maker, ask yourself: Does it have a clear differentiation advantage?
- Fragmented Industries
In sectors like fashion retail, brands such as ZARA, H&M, and Uniqlo each hold less than 5% of the market. In this environment, supply chain efficiency becomes key — who can get newly designed clothes from the factory to the store fastest?
Shein's rise was powered by China's mature textile industry and its “7-day fast restocking” supply chain model.
Market Size
Picking an industry is like choosing a city to invest in real estate — would you rather bet on a growing city with industrial upgrades, or a declining one losing population?
- Expanding Industries: The case of new energy vehicles
In 2020, the global electric vehicle (EV) penetration rate was under 5%.
By 2023, it had surpassed 25%, meaning the market grew more than fivefold in just five years.
Investing in leading players along the EV supply chain (like CATL or Tesla) during this period meant riding a high-growth wave.
- Declining Industries: Traditional internal combustion engine (ICE) markets
In many countries, the ICE vehicle market has peaked or even entered negative growth. If a traditional automaker fails to transition to electrification, it may eventually be phased out, no matter how high its current profits are.
Growth Drivers: What Propels the Industry Forward?
The underlying logic behind industry growth determines its potential scale and sustainability.
- Technology-Driven Growth
Sectors like AI and cloud computing grow through technological breakthroughs that create new demand.
For example, NVIDIA’s GPUs were originally developed for gaming, but surged in value due to booming AI computing needs. Its stock price rose over 20x in five years, all thanks to a technological revolution.
- Consumption Upgrade-Driven Growth
The health food industry benefits from consumers' willingness to pay more for organic and low-sugar products.
Oatly capitalized on lactose-intolerant consumers in Europe and the U.S., becoming a global brand in just a few years by understanding shifting consumer trends.
- Policy-Driven Growth
Global carbon neutrality goals have fueled rapid expansion in the solar and wind power industries.
Industry Risks
- Policy Risk
Before investing, always check: Is the industry supported by government policies? Are there regulatory red lines?
- Technological Disruption Risk
Digital cameras replaced film (Kodak went bankrupt), and streaming killed physical music sales (CD sales collapsed).
If you're investing in companies relying on outdated technology — like traditional transmission manufacturers in the auto industry — be alert to the risk of being replaced by EV technologies.
- Cyclical Risk
Industries like steel and oil are heavily affected by economic cycles.
(Source: Freepik)
