The annual report is the only published document that provides investors an annual snapshot of the company’s progress, so it is essential that investors spend some time and effort to read the content. Very often, important information can be gleaned from the annual report. So you should make the effort to read the annual report of the companies you invested in.
While you must be a qualified accountant to compile the report, you certainly do not need to be an accountant to read and understand the annual report. Below is a few pointers extracted from Singapore Stock Exchange (SGX) on how to read an annual report in 10 minutes.
1) Read the first two and last two paragraphs of the CEO/Chairman’s statements. This will give you an idea of the company’s performances. Do the same for management’s discussions and operational analysis.
2) Check if independent auditors gave a clean bill of health.
3) Look at the financial statements in the annual report and check for the following: i) Check if the net profits for the last 5 years are rising or falling. In general, avoid investing in businesses with new direction or in the midst of a turnaround because the risk of losing your investment is very high.
ii) Check if the sales or revenues for the last 5 years are rising or falling. A company with strong investment moats will witness strong performance in the long-term. Revenue is a good indicator on the strength of the business growth.
iii) Look out for the cash flow after working capital adjustments and assess if it is positive or negative. A healthy company should have sufficient cash flow not only for capital expenditure but also for acquisitions that can help to build the investment moats.
iv) Look out for net debt is rising or falling. An increasing debt should be warning sign that the company may be over leveraged. However, investor should not be too averse of companies borrowing for the purpose of business expansion. The key is for the company to strike a balancing act and ensure that debt is manageable.
v) Note if the dividends are rising or falling (as a % of net profits). However, sometimes investor should not be too obsessed with dividend payouts because it may be prudent for the management to re-invest excess cash through share buy-backs or even acquisitions to fuel growth.4) Look out for segmental breakdown in the notes to the financial accounts and review the sales and earnings for each segment to see if they are improving or declining. Sometimes, the notes may yield very interesting stories or even hidden assets not known to many retail investors.
5) For all areas which suggest deterioration, look for an explanation in the discussions or seek clarification from the company. Seek to understand the reasons for the data given.
Sometimes it may be a good practice to read the annual report of a company written 5 years ago and see if the management strategies proposed back then was executed in according to plan. If so, then all good. If not, then you should start to query the management on the basis of deviations.
In conclusion, the annual report contains a lot of useful data and investors should make the effort to spend some time reading it. The stock market is full of peril and it is your sole responsibility to ensure that your money is well invested.