Or, as a professional, you may have reason to do some research on a company, which may involve reading everything you can about that company including the annual report.
For some, this is intimidating at worst, boring at best. Books full of business-speak, jargon, legalese and financial data aren’t most peoples’ idea of must-reads for the beach. It’s with this in mind that it may be a good idea to find the simplest and easiest way to get the information you need out of an annual report without falling to sleep.
Keep in mind, the purpose here is not to make you a better investor or financial expert, but simply to help you get the most out of your reading of an annual report. Here are six ways:
Know the major sections of an annual report.
They are usually:
- Letter to Shareholders – Letter from senior leadership.
- Operations or Business Review – Summary of company performance in narrative form.
- Financial Review – A high-level view of the numbers at fiscal year-end.
- Management’s Discussion and Analysis (MD&A) – This is a detailed narrative breakdown of all the major developments and events .
- The Financials – Everything from the balance sheet to the income statement.
Go to School on the Letter to Shareholders.
Depending on the company and the format, the letter should appear in the first few pages of the annual report. This is typically where you get the most concise reporting of the company’s performance during the previous year, along with context and how that performance sets the company up for the coming year.
When people invest in a company, they invest in leadership, and that’s what makes this element of the annual report so critical.
The letter to shareholders is also where certain notable accomplishments may be featured, along with leadership’s vision for the future. The best thing about the letter is that it’s likely to be the most candid and direct assessment of company performance, written in everyday language.
The Letter to Shareholders usually provides a good starting point so that you are armed with questions as you find even more detail, and hopefully the answers you need, in the Operations Review and the Management’s Discussion and Analysis sections.
Dig in to the numbers.
Even if you are not financially inclined, once you have a good handle on what the company does, how it is performing, and what internal and external factors are influencing that performance, you can study the numbers more effectively. In fact, you may find yourself actually “reading the numbers,” or in other words, detecting a story pattern as you study those numbers. In a good annual report, those numbers will reinforce and complement the narrative you’ve just read.
The place to begin is the balance sheet. This is where you can get a quick picture of where the company stood at the end of its fiscal year.
The balance sheet features the company’s assets or all of the property it owns, and the company’s liabilities. These represent the company’s debt or what it owes.
As with any business, it’s always good to own more than you owe, but the difference between the two is called “shareholders’ equity.” When a company in total owns a lot more than it owes, it has more shareholders’ equity. Wall Street and investors like this.
This is where you can begin to conduct your own analysis. Has a company increased or decreased its shareholders’ equity from the previous year to this one? If it’s increased, find out why. If it’s decreased, find out why. The answers should be in the narrative of the annual report.
Other questions that can be answered by the balance sheet: Has the company’s total debt increased or decreased? You want debt to decrease, or you want a good reason for why debt has increased, such as borrowing to grow in promising markets.
I would recommend having a glossary of terms with you as you analyze these numbers and their associated descriptions so that you can best apply context to all of the very precise language and numbers in the financials.
Learn about EPS.
Then there is “earnings per share” (EPS). This is commonly used as a barometer for performance and it figures prominently in reporting from publicly traded firms. There are many formulas for what investors think constitutes good EPS for a particular company, and since I’m not a Wall Street wizard, I will leave that to them. But the main thing to know for our purposes here is what EPS is and why it’s important.
EPS represents the net income per share of common stock. This measure is used to indicate how much individual shares are impacted by corporate performance. There are many reasons EPS can fluctuate, from a company taking material charges for accounting purposes, rising costs, costs associated with acquisitions for growth, increased competition, and reduced market share. On the flip side, EPS can rise as profits increase and growth is sustained.
Zero in on Net Sales.
“Net sales” is the number that shows you if revenues have gone up or down since the last reporting period. Naturally, you want this number to rise year over year, but we know this is not always the case. By the time you get to this information, chances are you should have a good idea why this number is higher or lower. If not, that’s a question to jot in your notebook and further investigate.
Don’t forget the footnotes.
While no one can be expected to understand every piece of technical, financial or legal data contained in an annual report, it can pay to carefully review the footnotes in the annual report. This is where important elaboration can help you make sense of some of what you’ve read.
Obviously, these were just a few of the things on which to focus when you read an annual report. Since annual reports can vary in style and content, you may find that certain things like marketing, geographic growth, or even executive compensation, are more prominent in one annual report when compared to another.
But the key is to know that every annual report has a story to tell, often an interesting one, and it’s not that difficult to read.