Navigating the balance sheet to chart a firm's real value

If the financial crisis has taught us anything, it is that investors need to pay attention to the intrinsic value of companies.

Yet Hong Kong shareholders invariably focus on such things as price-earnings ratios or yields, both of which are important but mainly tell you how companies are performing relative to their share price, in other words, relative to the market's view of their worth.

More cumbersome, but ultimately more rewarding, is a study of company balance sheets. However, balance sheets are like politicians - they are very tricky and tend to obscure more than they reveal. Moreover, they are essentially a snapshot of a company's affairs on a given day.

As such, these accounts can be massaged to appear in healthy shape on that day by such means as booking sales in advance or fiddling with depreciation figures, etc. Some companies have a habit of excessive massaging, but over time their balance sheets remain the key to understanding what they are doing.

So as we come to the end of the reporting season, sitting on a pile of freshly minted company reports, let's see how we can make use of them.

The trick in reading balance sheets is to look at the areas where companies bury the embarrassing bodies, where they park the bad news and dress it up as good news, and where little time bombs are found ticking.

What follows is a quick guide to where to look when trying to discover the true state of a company's affairs. It is not a definitive guide and hardly infallible because as soon as one crafty way of hiding embarrassing information is exposed, new and more ingenious ways come to light.