What To Look For In An Annual Report
As an investor, you probably are very aware of the prices of issues you own and those you are thinking of buying. And if you are particularly concerned about current income, you also pay close attention to dividend payments. However, most investors know very little about the fundamental figures that support both the price of a company's stock and its dividends. Although we may know where those figures can be found, many of us don't bother to look. Therefore, paying attention to a few basic items in the quarterly earnings reports and the annual report can be very revealing.
It is the bottom-line results of operations that you are most interested in. This is the final number on the Consolidated Statement of Income, and always is underscored by two lines. It refers to the company's net-income (the money the company has left over after paying bills, salaries and wages, taxes, interest on its loans, and other costs of doing business), which is the key earnings figure and the first one you should locate.
Look at the trend of the net-income figure in the five-year financial summary that appears in most annual reports. You would want to see that the trend is upward. Even more important, note whether net income is increasing at a faster rate than "net sales." Some companies show the year-to-year percentage increase in each of these figures, so you can easily compare them. Other companies calculate and report "return on sales" (that is net profit divided by net sales) for each of the five years. Any increase in return on sales means that profit margins on the company's goods and services are improving. The prospect for even higher earnings in the future may also be good.
To update a company's earnings trend over the course of the year, look at the net-income figure in its quarterly reports, issued every three months. There is much less information in these interim reports than in an annual report, but the net-income figures for the most recent months are compared with net income during the same three months in the previous year.
If the year-to-year comparison looks good, do not automatically assume that all is well. Look through the report - including the Chairman's letter and the footnotes -for any mention of "extraordinary" income or events that may have pushed-up current earnings. You cannot count on one-shot infusions of income and you can usually do better with companies that increase their earnings through regular operations.
To check on the prospects for dividend income, look at the Consolidated Statement of Shareholders' Equity in the annual report. There you again will find the net-income figure, and you will clearly see how much of those earnings have been paid out in "cash dividends." The dividend is not likely to be in danger if net income runs substantially higher than dividend payouts.
Earnings not distributed to shareholders are called "retained earnings" and are reported in the Consolidated Statement of Shareholders' Equity. These are funds that are reinvested in the company's operations. If these retained earnings are substantial and are growing year by year, you would want to see that the company earns at least as much on funds reinvested in its operations as you do on your own portfolio, or that the company is growing or has plans for acquisitions. Otherwise, the company might as well have distributed these funds as dividends.
The simplest way to measure how well the company is doing with these retained-earnings funds is to calculate net income as a percentage of the figure for shareholders' equity, which you will find in the section of the annual report called Consolidated Balance Sheet. Companies that are particularly proud of their return on shareholders' equity usually calculate that figure themselves (net income divided by shareholders' equity) and feature it in the summary of key financial information in the annual report.
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It is the bottom-line results of operations that you are most interested in. This is the final number on the Consolidated Statement of Income, and always is underscored by two lines. It refers to the company's net-income (the money the company has left over after paying bills, salaries and wages, taxes, interest on its loans, and other costs of doing business), which is the key earnings figure and the first one you should locate.
Look at the trend of the net-income figure in the five-year financial summary that appears in most annual reports. You would want to see that the trend is upward. Even more important, note whether net income is increasing at a faster rate than "net sales." Some companies show the year-to-year percentage increase in each of these figures, so you can easily compare them. Other companies calculate and report "return on sales" (that is net profit divided by net sales) for each of the five years. Any increase in return on sales means that profit margins on the company's goods and services are improving. The prospect for even higher earnings in the future may also be good.
To update a company's earnings trend over the course of the year, look at the net-income figure in its quarterly reports, issued every three months. There is much less information in these interim reports than in an annual report, but the net-income figures for the most recent months are compared with net income during the same three months in the previous year.
If the year-to-year comparison looks good, do not automatically assume that all is well. Look through the report - including the Chairman's letter and the footnotes -for any mention of "extraordinary" income or events that may have pushed-up current earnings. You cannot count on one-shot infusions of income and you can usually do better with companies that increase their earnings through regular operations.
To check on the prospects for dividend income, look at the Consolidated Statement of Shareholders' Equity in the annual report. There you again will find the net-income figure, and you will clearly see how much of those earnings have been paid out in "cash dividends." The dividend is not likely to be in danger if net income runs substantially higher than dividend payouts.
Earnings not distributed to shareholders are called "retained earnings" and are reported in the Consolidated Statement of Shareholders' Equity. These are funds that are reinvested in the company's operations. If these retained earnings are substantial and are growing year by year, you would want to see that the company earns at least as much on funds reinvested in its operations as you do on your own portfolio, or that the company is growing or has plans for acquisitions. Otherwise, the company might as well have distributed these funds as dividends.
The simplest way to measure how well the company is doing with these retained-earnings funds is to calculate net income as a percentage of the figure for shareholders' equity, which you will find in the section of the annual report called Consolidated Balance Sheet. Companies that are particularly proud of their return on shareholders' equity usually calculate that figure themselves (net income divided by shareholders' equity) and feature it in the summary of key financial information in the annual report.
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posted by Bob Moser at
3:48 PM
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