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Understanding Annual Reports

By April 17, 2016 Newsletter No Comments

Let me share understanding annual reports.

Why you should Read the Annual Report and Where to get it

Some people may find financial documents boring, but understanding annual reports is necessary in building wealth. The good news is it gets easier once you understand the basics.

The annual report will provide you with company information you have to know, especially if you plan to hold a stock for the long term.

As a stockholder, the listed company should provide you with a copy of its annual report when it holds a shareholder meeting to elect directors. If you are not a stockholder, contact the shareholder service department to ask for one. You may also download it from the company’s Web site.

You may access the annual report on Form 10-K, which often contains more information on a firm’s financial condition than the “annual report to shareholders.” The federal securities laws require publicly listed companies to file this with the Securities and Exchange Commission (SEC), along with other documents such as quarterly reports on Form 10-Q, and current reports on Form 8-K.

Sometimes, companies prefer to send their annual report on Form 10-K to their shareholders instead of, or in addition to, providing them with a separate “annual report to shareholders.”

Companies may file their annual reports electronically in the SEC’s Electronic Data Gathering, Analysis, and Retrieval system (EDGAR) database.

What to look for when reading the annual report

Is the company doing well? Check if earnings and sales are higher, lower, or flat. These figures are presented in the income statement or financial section of the annual report.

Is the company making more money than it is spending? Check the balance sheet. Are the assets higher or lower than last year’s? Is debt growing, shrinking, or same as the preceding year?

What is management’s plan for the coming year? This is usually discussed at the beginning of the annual report, often through the letter from the board’s chairman.

You have to find out how the company started, where it is now, and where it is going. You don’t have to read all the pages, just jump from one important section to another to get the answers you need in deciding whether to buy, hold, or sell that stock.

Dissecting the Key Parts of the Annual Report

– Letter from the Chairman of the Board

This is usually found at the beginning of the document. It is used to highlight the company’s successes over the past year, but be careful because it is biased. If the firm is doing well, the letter will put an emphasis on this, but if it’s been through tough times, the letter will probably still put a positive spin on this.

When reading the letter, find out what it says about changing conditions in the company’s business and the industry in general. If there are difficulties, does it outline a concrete plan on how to steer the company back to the right track, such as cutting costs or shutting down money-losing branches?

Identify what the company is trying to highlight and why. For example, is it focusing on research and development for new products or a new deal with a key foreign investor?

Does the letter apologize for anything, such as failing to meet sales or profit targets, and does it explain the reason for the shortcoming?

Did the firm enter, or does it plan to enter, into mergers or acquisitions? How about other major developments such as penetrating a new market or sealing marketing agreements with a big company?

– Company Offerings

In this part, you will find out where the company gets its revenue. Try to understand what the company sells, what services it provides, and why customers buy them.

Check the sales of the company’s main offerings. How does it distribute them? Is it online, in malls, through a representative or other channels? Does it sell only to the U.S? or is it present in overseas markets? A company with wider distribution will have higher sales and in the end, a higher stock price. Check the political situation in the company’s markets. If it’s a war-torn or politically unstable country, it will have an effect on customers and the company, eventually affecting the stock price.

How do the company’s sales fare against its competitors? Is it a market leader? If the customers prefer the competitors over company, it will eventually affect the stock price.

 Financial Statements and Historical Financial Performance

You don’t have to be an accountant to understand the basics of financial statements.

First, look at the income statement, also known as the Profit and Loss statement or simply P&L.

The revenue numbers will show you how sales are doing. The expenses part will give you an idea if it is spending more than it is earning, and the net income or net loss numbers will show you the end result.

The revenue is also called top line because it is located at the uppermost part of the income statement, and the net profit or net loss is also called the bottom line as it is found at the bottom.

Check the balance sheet. It is a snapshot of a point in time, usually by year-end, that tells you what the company owns (assets), what it owes (liabilities), and the end result (net worth). Healthy companies have greater assets than liabilities. Don’t forget to read the footnotes to the financial statements.

Also, look at the summary of past financial figures to see the company’s progress over the years. Most reports summarize two years, and others, three years.

– Management Issues

In this section, management reports on the current trends and issues in the company, industry and economy. See if you agree with management’s assessment of market conditions and how they affect the firm’s prospects.

Accountant’s Opinion Letter

This is usually an opinion or paragraph written by the company’s independent accounting firm. It is an opinion on the accuracy of the financial statements and how they are prepared.

– Data on Identity of the company and its Subsidiaries

This will give you an idea of the company’s subsidiaries and other related firms, what they do, and where they are located. It contains information on brands, addresses, location of headquarters, as well as names of directors and officers and their stock ownership.

– Stock Information

This section will likely have a history of stock price movement. It also has information on what exchange the stock is listed on, the stock symbol, the firm’s dividend reinvestment plan, stockholder services and whom to contact for further information.

If you are a long-term investor, you should scan through the key parts of the annual report because it will provide you with information you need in building your wealth. Don’t forget to read through the chairman’s letter as well as the company’s products and services, financial performance, management issues, accountant’s opinion, subsidiaries and stock information.

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