Financial statements, the business cycle, economic indicators, cyclical and defensive sectors, and international factors

Three views of a company

A balance sheet reports assets, liabilities, and shareholders' equity on a date: assets equal liabilities plus equity. An income statement reports revenue, expenses, and net income over a period. A cash flow statement reports operating, investing, and financing cash flows over a period. Profit and cash differ: a credit sale can generate revenue before payment. Equipment purchases use investing cash; stock issuance generates financing cash.

The cycle and its signals

The business cycle proceeds through expansion, peak, contraction, and trough. Activity rises in expansion and declines in contraction. Peaks and troughs are turning points.

Leading indicators, including building permits and new orders, tend to turn ahead of overall activity. Coincident indicators, including industrial production and nonfarm payroll employment, move with current activity. Lagging indicators, such as average duration of unemployment, tend to turn afterward. These are tendencies, not precise forecasts or assurances about a particular company.

Cyclical sectors, such as automobiles and discretionary purchases, respond strongly to economic conditions. Defensive sectors, such as consumer staples and utilities, serve needs that persist during contractions. Defensive stocks still have market and business risk.

Economic theories

Keynesian theory emphasizes aggregate demand and fiscal stabilization. Increased government spending or reduced taxes can stimulate weak demand. Monetarist theory emphasizes the money supply's relationship to nominal activity and inflation and favors predictable monetary growth over discretionary fine tuning.

International measures and currencies

Gross domestic product (GDP) measures final goods and services produced within national borders during a period. Gross national product (GNP) follows production attributable to residents: GDP plus residents' production income from abroad minus corresponding income earned domestically by foreign residents. Excluding intermediate goods as separate additions prevents double counting.

The balance of payments records residents' transactions with the rest of the world. The current account includes trade in goods and services, income, and current transfers. The financial account records cross-border investment flows. A trade deficit is narrower than the balance of payments.

Appreciation increases a currency's purchasing power in foreign currency; depreciation reduces it. Other things equal, dollar appreciation makes imports cheaper for United States buyers and exports more expensive for foreign buyers. Depreciation reverses those effects. A foreign investment's dollar return reflects both its local performance and exchange-rate changes; an unchanged local asset price can yield a dollar loss if the foreign currency depreciates.