Many investors start their search for winning stocks by looking at a company’s income statement and balance sheet. But it helps to remember that earnings are adjusted and that some items in a corporate report are more useful to investors than others.

A company’s earnings are different from an employee’s salary. Earnings are indefinite and subject to revision, even years later. Companies have to estimate many costs, and make yearly write-offs against earnings, according to arbitrary rules.

When it comes to examining a company’s earnings statement, here is some investing advice on specific items that we think merit special attention:

• Research spending. Companies mostly write off research costs when they spend the money, depressing the year’s earnings. Some research turns up nothing of value. But research can lead to new or improved products that generate huge future profits and cause a winning stock pick’s shares to soar.

• Depletion write-offs. Mining companies take yearly write-offs against earnings for sums that represent depletion of their mineral reserves. These deductions are supposed to offset the cost of finding and developing new mineral deposits as old ones run out of ore.

  However, mining companies base depletion charges on costs—what they spent to find and develop current mineral deposits. But there’s an element of chance in all exploration. You can never be sure a mine will be profitable until production begins. The same exploration outlay may not turn up an equally rich deposit, or anything of value. When a mining company exploits a rich deposit, its earnings may be partly a return of the original investment. It is advisable to get professional advice when you are not familiar with a stock sector.

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• Goodwill write-offs. When one company buys a business for more than the value of tangible assets, such as land and equipment, it treats the excess as “goodwill,” or “value as a going concern.” Every year, the company assesses its goodwill and adjusts its value accordingly. For example, if the value of the acquired business has declined, the company will write off a portion of its goodwill.

  However, goodwill needn’t lose value or depreciate every year. With proper management, the acquired company’s value as a going concern may rise.

To profit from earnings, look at them in context, and consider the historical pattern. It’s a good sign if a company makes money every year, and successful investors mostly avoid chronic money losers, no matter how cleverly they adjust their earnings reports.

COMMENTS PLEASE—Share your investment experience and opinions with fellow TSINetwork.ca members

When you look at a company’s earnings report, what do you concentrate on? Would you buy a stock without looking at its financial reports? Let us know what you think.