How to Read an Annual Report - Part 1
An investor should always study a company's annual and quarterly reports with a critical eye. The financial statements found there are the basis for fundamental analysis because a company's current and past performance are seen as the primary factor in a stock's value. And the discussion sections will give you valuable insight into management's thinking and, hopefully, the quality of their leadership.
Most annual reports will contain the same basic elements, sometimes with different titles and emphasis.Understand the purpose of each and know how it should impact your overall decision to buy, hold, or sell the company's stock. The report contains a letter to shareholders, usually from the chairman, president or CEO, and clearly is directed to you, the investor. The letter will talk about the company's performance over the past year in relation to the plans and goals set out in the previous report. If the year's performance has differed significantly from what was forecast a year ago, explanations will be provided. A plan for the upcoming year or more is set out and probably includes some additional expectations and goals.
Don't just glance through it, but rather, look at the contents of the letter critically. Is the leader or management team clear about the direction they are taking the company? Do they state their goals and how they plan to achieve them? How do the current goals compare to what management has stated in the past? Do they talk about growing the company or only focus on products and services that currently are doing well? Are you aware of any significant issues that management has ignored?
The next element is usually some type of company summary or overview. This explains how the company operates and provides information about products or services and how the company makes money. It probably includes a discussion of current trends affecting the business and lays out the plans for moving the company forward. It may expand on plans and goals mentioned in the shareholder letter.
Again, look at this information with a critical eye. Can you understand how the business works and what makes it profitable? Is management changing the core business or focusing on an area in which they have not worked before? If so, what will this mean to future business? A new product launched into a traditional area should not be cause for alarm. But focusing significant company resources on a new and uncertain area may give one pause.
In both the letter and the overview, traits can emerge that should make you think about the quality of a company's management. Compare those who blame the market, the economy or other outside influences to those who admit failure or own up to not forseeing an unfavorable trend that has had a negative impact. Good management will explain their plans for the future and be open about the possible risks. It also will discuss how they will handle risk and quantify their expectations for growth and profits.
The Management Discussion and Analysis (MD&A) section is a required disclosure mandated by the SEC. This section is the management team's discussion of both the results of operations during the year and plans going forward. The MD&A is a source of good information for fundamental analysis and often is an easier-to-understand summary of key points in the financial statements. Why were revenues up or down? How about gross margins on earnings and earnings per share? What is the current state of the facilities and equipment? Is there discussion of upgrading older equipment or replacing it with new? Is there a mention of new factoies or service centers?
The MD&A also can provide information about significant upcoming changes in the company's condition. Does it look like certain plans will create a significant amount of new debt? Are future stock offerings planned that may raise new capital but dilute the value for current shareholders? If significant capital expenditures are planned, how will they be financed? Information presented in the MD&A can provide clues to management's expectations for the future and how they will achieve them.
Search for comments on competition or other challenges that the company may face in the future, and compare these to comments made about the current year. Look at the history of revenue and earnings growth in the financial statements. If the same management team has been able to grow the company consistently over a five-to-ten-year span, you can feel more confident that they have successfully faced a variety of challenges. When you invest in a company, you are really buying the current management team. Read the MD&A section of the annual report to find out how management is doing.
- Next time: Part 2 - The Financial Statement
* * * * *
Most annual reports will contain the same basic elements, sometimes with different titles and emphasis.Understand the purpose of each and know how it should impact your overall decision to buy, hold, or sell the company's stock. The report contains a letter to shareholders, usually from the chairman, president or CEO, and clearly is directed to you, the investor. The letter will talk about the company's performance over the past year in relation to the plans and goals set out in the previous report. If the year's performance has differed significantly from what was forecast a year ago, explanations will be provided. A plan for the upcoming year or more is set out and probably includes some additional expectations and goals.
Don't just glance through it, but rather, look at the contents of the letter critically. Is the leader or management team clear about the direction they are taking the company? Do they state their goals and how they plan to achieve them? How do the current goals compare to what management has stated in the past? Do they talk about growing the company or only focus on products and services that currently are doing well? Are you aware of any significant issues that management has ignored?
The next element is usually some type of company summary or overview. This explains how the company operates and provides information about products or services and how the company makes money. It probably includes a discussion of current trends affecting the business and lays out the plans for moving the company forward. It may expand on plans and goals mentioned in the shareholder letter.
Again, look at this information with a critical eye. Can you understand how the business works and what makes it profitable? Is management changing the core business or focusing on an area in which they have not worked before? If so, what will this mean to future business? A new product launched into a traditional area should not be cause for alarm. But focusing significant company resources on a new and uncertain area may give one pause.
In both the letter and the overview, traits can emerge that should make you think about the quality of a company's management. Compare those who blame the market, the economy or other outside influences to those who admit failure or own up to not forseeing an unfavorable trend that has had a negative impact. Good management will explain their plans for the future and be open about the possible risks. It also will discuss how they will handle risk and quantify their expectations for growth and profits.
The Management Discussion and Analysis (MD&A) section is a required disclosure mandated by the SEC. This section is the management team's discussion of both the results of operations during the year and plans going forward. The MD&A is a source of good information for fundamental analysis and often is an easier-to-understand summary of key points in the financial statements. Why were revenues up or down? How about gross margins on earnings and earnings per share? What is the current state of the facilities and equipment? Is there discussion of upgrading older equipment or replacing it with new? Is there a mention of new factoies or service centers?
The MD&A also can provide information about significant upcoming changes in the company's condition. Does it look like certain plans will create a significant amount of new debt? Are future stock offerings planned that may raise new capital but dilute the value for current shareholders? If significant capital expenditures are planned, how will they be financed? Information presented in the MD&A can provide clues to management's expectations for the future and how they will achieve them.
Search for comments on competition or other challenges that the company may face in the future, and compare these to comments made about the current year. Look at the history of revenue and earnings growth in the financial statements. If the same management team has been able to grow the company consistently over a five-to-ten-year span, you can feel more confident that they have successfully faced a variety of challenges. When you invest in a company, you are really buying the current management team. Read the MD&A section of the annual report to find out how management is doing.
- Next time: Part 2 - The Financial Statement
* * * * *
posted by Bob Moser at
6:32 PM
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