If you're looking for a way to boost your stock returns, horizontal analysis is the key. This formula can help you understand how a public company is performing financially compared to previous years. In this blog post, we will discuss what horizontal analysis is and how to use it to improve and make better stock investment decisions. We'll also provide a few examples to help illustrate how it works. So, are you ready to start mastering horizontal analysis? Let's get started!
What is horizontal analysis?
Horizontal analysis is a method for calculating the relative changes in financial performance over time. It involves comparing financial information from one year to another and analyzing the differences between them. This type of analysis will help you identify trends and measure how well a company performs against its competitors or previous years.
The horizontal analysis formula is typically expressed as the percentage change in a financial ratio from one year to the next or as a dollar amount.
Using Horizontal analysis, you could, for example, compare the following financial performance items:
- Gross Profit Margins
- Operating Expenses
- Net Income
Horizontal analysis formula
The horizontal analysis formula is relatively simple. It involves taking the difference between two years (current year minus base year) and dividing it by the base year amount, then multiplying it by 100.
Mathematically, it looks like this:
(Current Year – Base Year) / Base Year × 100 = Percentage Change from Last Year
For example, if your company's revenue was $100,000 in the base year of 2019 and $120,000 in 2020 (the current year), using horizontal analysis, you would calculate the percentage increase as follows:
($120,000 – $100,000) / $100,000 × 100 = 20% Increase from Last year
How to perform horizontal analysis
Performing horizontal analysis is relatively simple, but it requires understanding the fundamentals of financial statements. Below you can find the step-by-step process to follow.
1. Select the financial items you want to analyze.
First, you need to select the financial items that you want to analyze. This can include items like revenue, expenses, net income, and cash flow. In addition, for different companies, you may want to look at additional financial items. For example, if you're analyzing a retail company, you may want to look at inventory levels and sales.
2. Calculate the horizontal analysis formula for each item you selected.
Using the formula described above, calculate the horizontal analysis formula for each item you selected. This will give you an understanding of how each item has changed from the base year to the current year. The base year can be any period you choose; typically, this is year to year, quarter to quarter, or past trailing twelve months.
3. Compare the percentage change in the items for each year to identify trends or patterns.
Once you have calculated the horizontal analysis formula for each item, it's time to analyze the results. Look at the changes from one year to the next to identify trends or patterns. Are certain items increasing or decreasing? Are there any anomalies that you need to take into consideration? By understanding the trends and patterns in your horizontal analysis, you can make better decisions when it comes to deciding to invest in a particular company.
4. Analyze the results and make comparisons to industry averages or the company's competitors.
Finally, it is important to compare the horizontal analysis results with industry averages, as well as with the company's competitors. This will help you determine whether the company is performing better or worse than its peers in similar industries and provide you with a more complete picture of its financial performance.
Example of horizontal analysis
Using Apple Inc as an example, let's look at horizontal analysis of their financial statements for the years 2019 and 2020 to illustrate what horizontal analysis looks like in practice.
In 2019, Apple's Revenue was $260.174 billion, and in 2020 it increased by 5.51% to $274.515 billion. Using the horizontal analysis formula, we can calculate this as follows:
($274.515 – $260.174) / $260.174 × 100 = 5.51% Increase from Last year
In 2019, Apple's Gross Profit Margin was 37.82%, and in 2020 it increased by 1.1% to 38.23%. Using the horizontal analysis formula, we can calculate this as follows:
(38.23 – 37.82) / 37.82 × 100 = 1.1% Increase from Last year
Compared with one of its biggest competitors, Microsoft, horizontal analysis shows that Apple's Revenue growth and gross profit margin were lower than Microsoft's in both years.
In 2019, Microsoft's Revenue was $125.843 billion, and in 2020 it increased by 13.65% to $143.015 billion. Using the horizontal analysis formula, we can calculate this as follows:
($143.015 – $125.843) / $125.843 × 100 = 13.65% Increase from Last year
In 2019, Microsoft's Gross Profit Margin was 65.9%, and in 2020 it increased by 2.85% to 67.78%. Using the horizontal analysis formula, we can calculate this as follows:
(67.78 – 65.9) / 65.9 × 100 = 2.85% Increase from Last year
By analyzing horizontal analysis of both Apple and Microsoft's financial statements, we can see that Microsoft had higher Revenue growth and Gross Profit Margin than Apple in both years.
Horizontal analysis template
In the old days, you had to manually copy-paste the data from a source into your spreadsheet and then perform the horizontal analysis calculations on your spreadsheet. The good news is that you no longer have to do that.
Using Wisesheets, you can set up a template that automatically retrieves the data of any company/s you are looking for automatically by changing the ticker.
This allows you to focus on your analysis and analyze hundreds of stocks so much faster.
You can sign up for a free Wisesheets account here so you can try it for yourself, and you can click here to download the free template, which automatically provides you with the data.
Horizontal analysis is an important tool for investors and analysts to understand a company's financial performance. By analyzing horizontal changes in financial statements such as income statement, balance sheet, and cash flow statement, you can make better decisions when it comes to investing in a particular company.
Therefore, horizontal analysis provides essential information for making investment decisions and understanding how a company is doing. It also provides valuable insights into the performance of the company's competitors so that you can compare and contrast their relative performances. Finally, horizontal analysis can be automated through the use of tools such as Wisesheets, which provide templates to quickly pull data and make horizontal analysis calculations much easier and faster.