Editor's note: Longtime Digest readers know all about the simple approach under which Porter Stansberry founded our company in 1999.

To this day, it's what Stansberry Research analysts and editors aim to do with everything we publish... Give our subscribers the information we'd want if our roles were reversed.

But it's far from the only valuable advice Porter has dished out in the past two decades...

In today's Masters Series essay – adapted from the July 16, 2018 Digest – our director of research, Austin Root, recalls a "secret" that Porter shared with him before he wrote his first Digest. Austin found it more challenging to follow this piece of advice the second time...

However, as you'll see, he focused on an essential tool that everyone must know how to use in order to make great investing decisions. And by doing so, you'll improve in another way, too...

Use These Key Tools to Guarantee You'll Make Better Investing Decisions

By Austin Root, editor, American Moonshots

Sometimes, I struggle to follow simple instructions...

The first time Porter asked me to write the Digest, he gave me one straightforward piece of advice...

This is important: The secret to writing a good daily letter to our readers is to focus on one idea. Whatever you write about, just tell them – simply and directly – one thing that will help them make better decisions.

I took this advice to heart when I wrote my first Digest in May 2018 (which you can read right here). But this time, it seemed... harder.

I know what I want to show you. It's a simple set of skills I first learned in business school... and used constantly during my time managing investments for a variety of Wall Street firms.

These skills are guaranteed to help you make better investing decisions. Best of all, they're easy to learn and available to anyone with an Internet connection.

But few individual investors know about them, let alone realize how they can improve their investing decisions.

My problem was, every time I started laying out these skills, my ideas took me in too many different directions. Until I thought about my grandfather...

When I was a kid, I used to spend hours helping my grandfather with "home-maintenance projects." During these tasks, he often said that half the solution to any job was having the right tools.

Imagine trying to hook up the plumbing for a bathroom sink...

You can spend an hour scraping your knuckles and cursing if you try to do it with a simple set of pliers. But break out a plumber's wrench, with its long neck and angled head, and you can hook up those pipes in a matter of minutes.

That's exactly how I feel about investing as well... To consistently make great investment decisions over the long term, you need to have the right tools. And to me, one of the most valuable tools in any investor tool kit is a basic understanding of corporate financial statements.

Now, before I get started, chances are good that you're probably thinking...

Why do I need to get into the weeds and look at the financial statements? I buy the stocks of companies that produce products or services that I understand, use, and love – like Apple (AAPL), Alphabet (GOOGL), and Amazon (AMZN).

You're right... Putting your money into companies that make products ingrained in our daily lives is an excellent first step in identifying great investments. But it isn't always foolproof...

Sometimes, great products don't translate into great stocks.

For example, my family is a frequent flier on Southwest Airlines (LUV) and a loyal user of leading products made by Kraft Heinz (KHC) – such as Philadelphia cream cheese and Heinz ketchup. But the stocks for both parent companies have been lousy performers of late...

Over the past two years, Southwest shares have lost about 3%, assuming reinvested dividends. And Kraft Heinz has fared much worse... Its shares are down more than 58% over the same time frame. These returns compare with a gain of more than 18% for the S&P 500 Index during the same span.

When you look at the financial statements of these companies, the reasons for the underperformance become more clear... Southwest's sales growth has slowed, and its profits and profit margins have declined. Kraft Heinz has a similar story, but it's even more pronounced, including outright sales declines.

Understanding financial statements may have helped you avoid both these stocks.

So what are the key tools?

Let's first start with the balance sheet...

Among the three main financial statements, this one gives a snapshot of a company at a specific period of time. It shows what a company owns (the assets), what it owes (the liabilities), and the difference between those two numbers (the net equity). All else equal, you'd want to invest in a company with a larger asset base, fewer liabilities, and, therefore, a greater net equity value.

The balance sheet is sometimes called the "stock" statement... It takes stock of what a company owns and owes at a moment in time. The other two statements – the income statement and the statement of cash flows – are often called the "flow" statements. They measure items generated over a specified period of time. For example, an annual report will show the flows generated over the course of a year.

In general, the income statement measures how well a company is performing...

It tells you how much total business a company generated (its revenues) and subtracts what the company spent (its expenses). The net result is its profits, or net income. Again, all else equal, you'd prefer to invest in a company with higher revenues, lower expenses, and, therefore, higher profits (and a higher profit margin).

However, many investors miss one key nuance about the income statement...

Many of its line items are smoothed out (or shown on an "accrual" basis), rather than shown on a true cash basis. This is done, in part, to account for large, lumpy items that may not occur every period but represent an ongoing part of the business.

For instance, consider a software company that sells its customers three-year licenses to its software. It receives the cash up front, but it provides services (and incurs expenses) over the course of the next three years. If the company recorded all the revenues in year one, this would overstate ongoing profits in that year, and then understate profits in years two and three. Instead, the income statement books the revenues in the period in which it's earned, not when the cash is received.

Smoothing this and other lumpy items out allows us to meaningfully compare a company's performance from period to period. That's important... Investors want to see not only how well a company performed this year, but also how that compares with previous years. This comparison provides rate-of-change information that can be as important – or more important – than the absolute number itself.

This smoothing effect is also what makes the statement of cash flows important...

Many investors overlook this third statement, but longtime Stansberry Research readers know we consider it to be "mission critical." That's because the cash flow statement shows how much actual cash a company generated.

Of course, this might make numbers jump around from year to year, if a company spends a lot one year on a new factory and nothing on such capital expenditures the next year, for example. But at the end of the day, we want to know about the cash. And the more cash a business generates over time, the more valuable the company is.

Another reason the statement of cash flows is so important is because it provides the quickest and best way to determine a company's free cash flow ("FCF"). Many Stansberry Research analysts and editors rely on FCF to evaluate whether a company's stock is attractive...

FCF is what's left after the company pays for all expenses and outlays. That makes it a great measure of the excess cash a company generates that can be used to enrich shareholders through dividends and share buybacks, or to invest in incremental growth.

When you want to calculate a company's FCF, go to the statement of cash flows. Take the "net cash from operating activities" and subtract the capital expenditures. Again, all else equal, the higher this number (and the higher FCF as a percent of revenues), the better.

The next time you think about investing in a company, take a hard look at its financial statements...

Print out this "cheat sheet" summary of the three financial statements to have at your side as you go through the numbers.

It won't happen overnight, but a better understanding of these financial statements will be a valuable addition to your investing tool kit. You'll have a better perspective on how a business operates. And you'll be better at avoiding "good products, bad financial statements" scenarios.

This deeper level of understanding should help you ultimately make better investment decisions, particularly in times of heightened market fear or greed.

I almost forgot to share the other major benefit to understanding financial statements...

This, by the way, is why I said earlier that I struggle with the simple instruction of keeping the Digest to just one idea. But it's important to share...

In fact, for many of you, I bet this second benefit is actually more valuable than the first. To get this benefit, all you need to do is start thinking of your own life in terms of financial statements.

Just like the ones used by businesses, personal financial statements equip you with better information about your overall well-being. At a basic level, this will help you with budgeting and managing large purchases (like a car or house)... and will even provide a more accurate assessment of your overall financial condition. Taking them a step further, you can use these financial statements not only to measure your finances, but to actually improve them.

For instance, once you've laid out your personal balance sheet, you can begin to optimize it. Pay down high-cost debt. Increase your investments in assets that generate better rates of return.

Or you could use your personal income statement or statement of cash flows to better analyze how much of your income goes toward various types of expenses... And then adjust your spending levels accordingly.

That doesn't mean you need to cut out all the fun and frivolous expenses, or eliminate all large assets that tend not to hold their value (like cars or boats). By all means, enjoy your wealth and the fruits of your labor.

But I am saying it's time you become aware of how your personal financial statements stack up. You may find some ways to improve your finances that have no impact on your daily life... And take it from me, finding and eliminating those expenses is a great joy in and of itself.

Familiarize yourself with financial statements... I'm confident that doing so will provide you with invaluable tools to help make you a more informed, better investor, and improve your personal financial operations. These are two keys to improving your net worth over the long run.

Good investing,

Austin Root

Editor's note: Now that you know the importance of financial statement analysis, the next step is to use this tool to make better investments. And right now, to take the next step, we urge you to check out Austin's American Moonshots product.

This isn't like our typical service. In Moonshots you'll find a fully allocated portfolio of a dozen under-the-radar companies – Austin calls them "tomorrow's blue chips" – that have the hallmarks of financial health that Austin described today. Click here to learn more.