How To Read Annual Reports When Investing In Stocks

| January 26, 2011 | 0 Comments

how to read annual reports Company annual reports are typically glossy publications which contain fancy photographs and colourful diagrams and charts telling you about the company’s performance over the past year. Even though it might not seem like it’s the case, there is actually no mandatory rule which specifies the quality of paper that an annual report must have. However, how the actual annual report looks and feels, tells you about the company’s image and its marketing strength.

If you skip the fancy stuff, you’ll find a lot of numbers in the annual report. Besides the pages of numbers, you’ll also find narratives and statements from the company. You can expect these narratives to be 100% positive, all the time.

However, the things that most people are really concenrned about with regards to the annual report are the P&L (profit and loss) statement and balance sheet. The P&L statement tells you about the company’s financial performance, i.e. how much profit the company is making. This is different from revenue, which is shown as turnover. You’ll also find a number for the company’s expenses over the year. Profit is simply income minus expenses, but there’s also interest (earned and paid) that has to be considered too. After all of that, you’ll arrive at a profit, or loss, before tax. How much tax the company needs to pay, what dividends are paid to shareholders, and any retained profits will also be shown in the profit and loss statement.

The balance sheet is a document that tells you about any inter-group loans that the company has, and about any investments it has made, and about cash and debt positions it has. You’ll generally notice that most companies on the stock market actually own a number of subsidiaries. As such, there’s usually a consolidated balance sheet that tells you the assets and liabilities of all the different businesses. On top of this, you’ll also get a balance sheet for the main parent company.

Don’t get too stressed about these though. It does look daunting, but you can always start from the financial summary, which provides the financial highlights for the past 2-5 years. With this summary, you can see how the profits, as well as earnings, dividends and net asset value per share has been over the years.

In summary, here are some important points to look out for when reading annual reports:

  • Cash flow: Cash is king, and a company with a strong cash flow has the necessary means to expand, or survive tough times.
  • Turnover: This is vital because a company could be making $100 million, but spending $200 million. Find companies that have positive turnovers, and you should see that earnings per share should be too.
  • Profits: Needless to say, profits is crucial to identify a strong company. A trend of growing profits year after year is something to look out for.
  • Dividends: This can be a source of income for investors, especially companies that give an increasing dividend amount over the years. Compare the company’s earnings per share to its dividends per share to discover about the company’s dividend policy.

Although the company’s annual report gives you a good feedback about a company, you have to be aware that this is past performance and is in no way a guarantee of the company’s future performance. Do your due diligence, especially in the industries that the company is operating in, and keep yourself up to date through the news and trade magazines.

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Category: Learn to Invest & Trade

About the Author ()

John Tan has been Vice President of BlueTrust Investments Corporation for 6 years since the mid-90’s. He has since moved on, to be a professional full-time trader.

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