Using Annual Reports to Research A Company
I have just begun my study of understanding all of the information that is contained in an annual report. I have learned that understanding and using annual reports is absolutely necessary in performing complete research for a stock that you are considering for possible purchase. The annual report should be used in conjunction with the Stock Selection Guide (SSG). This page will explain the various sections contained in an annual report.
Introduction
Annual reports are easy to obtain. Just call or write the company's Investor Relations Department - it will arrive promptly. If it doesn't that's a clue in itself? All public companies are required by federal law to submit an annual report to their stock holders of record. The report must contain certain information, and figures. Keep in mind that annual reports are also used by the company for advertising - the reports are often beautifully presented works of art. Keep in mind companies use their annual report as a method of advertising - you have to separate the "wheat from the chaff " It's what's in the report that's important - keep focused on the numbers not the art work!
Letter To Shareholders
Board of Directors/Co. Officers
Financial Section
Notes To The Financial Section
Report of The Independent Auditor
The first pages of most annual reports represent the president's report/letter to stockholders.
- In general, easy to understand terms, the CEO tells the world what is going on within the company. What is important, what challenges do they face, what are the company's goals? This is fine except you need to read it critically - is the CEO giving you the good and bad of the company, or just "fluff" about how great a company it is.
- Look for Reports and Company Forecast's from each operating division.
- Usually, after the president's report each operating division gives a one page summary of what happened in the past year, and what will happen this year in terms of new products, plants, markets and technology.
Board of Directors/Company Officers
It is important to understand who these people are - they are elected to make decisions on your behalf as a shareholder. The report should list their biography, who they work for. You are trying to figure out how the members can contribute to the overall growth of the company.Financial Section
(the nuts and bolts)
The most important part of the annual report. There are five major parts that make up this section. You are trying to determine if the company is making money, particularly over the last 5 years. We are looking for a growing company.
Balance Sheet - Shows what the company owns (assets) and what it owes (liabilities) at the end of the fiscal year. Its called a Balance Sheet because it shows both sides of the company's condition. On one side are the assets on the other side are the liabilities and shareholders' equity. The two sides are always equal in value.
Assets = Liabilities+ Shareholder Equity
(See Sample Nuts & Bolts Balance Sheet) for detailed explanation.- Income Statement - Did the company have a profit or loss. This is also called the Profit and Loss Statement. It shows income, costs, expenses, and profits/losses. (See Sample Nuts & Bolts Income Statement) for detailed explanation.
- Shareholder's Equity - Shows what's left over after subtracting the liabilities from the assets.
- Cash Flow Statement - This part shows changes in the cash balances.
Notes To The Financial Statement - This section can give you lots of information about what's going on with this company. You can find information that might tell you there are problems "brewing" - for example, pending lawsuits (which can be good if the company is doing the suing - if they win it can mean income the company wasn't counting on. On the other hand often the company has a lawsuit against it - not uncommon. How big is the suit and does the company have the money to settle if they lose? Another important area in the "notes" is any accounting procedures that have changed - what does the change mean and why was it done. In short read all notes carefully.
Report of The Independent Auditor or Accountant -
This report can be found at the back of the annual report. You need to keep in mind that the company hires the auditor to perform the annual audit of the company. The auditors' report is a summary of the results of an audit, or examination, of the financial statements by an independent firm of certified public accountants. The audit is an attempt to determine whether a company's financial statements report the company's financial status accurately and reliably. If the auditors consider the statements are fair presentations of the company's financial position, they issue an "unqualified" opinion. When you read the Auditor's Report there will probably be standard text that says something to the effect that the annual report has been fairly stated and is in conformity with general accepted accounting principles. You should be alert to anything that suggests the company is having financial problems - in other words look for another company to research.
Resources Used In This Guide:
IBM Guide To Understanding Financials
ABC News - How To Read An Annual Report
Invest-O-Rama - Balance Sheet Analysis
Los Angeles Times - Picking Up On Picking Stocks
Balance Sheet & Income Statement
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