Your Questions About Stocks And Bonds Basics

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Robert asks…

Reading a Company’s Annual Report at an Investor’s Standpoint?

I am young and new to investing, especially in the stock market. I have to admit that I have not yet gain broader principles and tactics on investing other than the basics, nor that I have the necessary capital to risk in investing an any other securities that aren’t as protective as cash equivalencies (money market account, savings bond, certificate of deposits, etc) but I am ready to do extensive research on companies I’m willing to invest in. And my research had lead me to a company’s annual report.

I had a glimpse of my potential company’s annual report, but man, it was longer than I anticipated. In addition, I don’t know exactly how I’m suppose to ‘go about’ analyzing the information in it. Although not left in the dark, I was overwhelmed.

Can somebody give me some pointers in deciphering an annual report? Other than the obvious, could someone advise me on what areas of an annual report that fundamental investors strongly considers looking at over the rest?
Okay, ANY kind of help would suffice.

financi4 answers:

The Annual Report, or 10-K in investor parlance, is the summary of the company’s operating performance in a given year. The first page of any annual report (apart from the glossy marketing material) is a standard page identifying the dates that are covered, the number of outstanding of shares, and the given value of the shares.

It is generally useful to have a minimum of 5 annual reports for a given company: the 10-k of the given year, the 10-k from some prior year (best if it was an especially tough last year), the 10-k of a competitor from the same year and also from another prior year, and a 10-k from a company that does business with your company.

Why so much reading? The point is to get a perspective on how the company is doing business. The annual report typically has a section called the MD&A, or manager’s discussion and analysis. Read this! It gives an idea of what the numbers mean in the given economic enviroment (or at least, it should make things clearer…what is management considering, reporting, etc?)

The next section of real importance is the financial numbers: look for the balance sheet (and look sharply at the numbers!). Does the company carry a lot of debt? Does the company have adequate credit? What assets are being claimed? (lots of accounts payable in liabilities? Lots of accounts receivable and little cash? Etc.)

Then, turn your eyes to the Income Statement. How is the company making money? Do you know the company’s model? Strategic advantage, or ‘edge’? Do the numbers make sense? (Here is where having prior statements helps, or having a competitor’s statement helps.) If the company says it will grow earnings by 20%…is this claimed by its competitors as well? Maybe the whole market is growing (excellent!) Or maybe the market is shrinking, but this company is tough as nails.

Finally, check the Cash Flows. Though this is a short-sighted look at a company’s operations, many investors like to see this because it is hard to really cloud the cash picture. You either have cash, or you don’t.

Start by reading a book like “Financial Intelligence.” It will help you go through more of the finer points of the annual report. Look on www.footnoted.org, the lady there has an excellent book on reading annual reports/quarterlies and spotting financial ‘red flags.’ Michelle Leder’s “Financial Fine Print” is excellent.

Then, look at your company’s “footnotes.” Remember always that the annual report is a “PR communication” from the CEO / management to investors.**Think critically!

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