Most people who invest in stocks will receive the Annual Report of companies they have invested in. But, after a quick flip - to look at the pretty pictures - and maybe a speed-read of the chairman's report, the booklet is left in a corner to gather dust, or worse, dumped into the wastepaper basket.

Annual Reports are more than just glossy booklets with carefully chosen illustrations and a mass of figures. They are definitely worth more than five minutes of your time. Careful study can tell you what was going on in a company at a particular point in its life - the last day of its financial year - and what its prospects are for the future.

Why Should You Bother?

Say you have bought $10,000 worth of shares of Good Fortune. Well, what does the company do? Does its future look bright? Or will the next six months see it gasping for breath? Should you sell out, hang on or buy more?
Or maybe you are thinking of investing your hard-earned money in that company which took the market by storm with its instant coconut milk. OK, sales are up. But are profits rising or falling? Is it still spending on research and development to keep one step ahead of the competition?
The clues are all in the company's Annual Report.

Start from the Back

First, turn to the auditor's report. Every Annual Report has one. The auditor is the independent accountant who by law has to vet the Annual Report and tell you whether it conforms to 'generally accepted accounting principles'.


Watch out for the phrase 'subject to'. This means the third party accountant is telling you that the Report is clean only if you take the company's word about the particular piece of business . . . and the accountant is not too sure that you should. Usually these disagreements are settled long before the Annual Report is printed. So if a 'subject to' finds its way into the Annual Report, this could mean trouble.

And if a 'subject to' is coupled with a change in auditors, this could mean even more trouble. Companies which change auditors frequently may be shopping round for one who will agree with the company's way of looking at things.

Next, the Footnotes

Yes, do read the footnotes next. Often, the whole story is told here. Are earnings up? This may not mean much if they were boosted by extraordinary profits from the sale of a piece of land -a windfall which is unlikely to happen again next year.

The footnotes are also the place to look for possible pitfalls: you can be sure that the company will not confine anything that is good in small print.
Some possible negative factors to look out for are:

• markdowns on inventories held (the accountant's word for stocks) if the company is stuck with outmoded or unsaleable items,
• higher cost of materials which may put a squeeze on
• plans for new buildings or equipment that may strain company resources,
• revaluation of buildings and land to make assets figure look good,
• upcoming union negotiations which may affect labour costs drastically, and
• adverse government regulations or trends in the industry.

What Happened, and Why?

Now, turn to the front for the chairman's statement. This is often the most revealing part of the Annual Report as the chairman has o face up to reality and tell you how his company fared. Most important of all, he must tell you why. If he does not, then listen to the tone of his statement. It is not too difficult to read between the lines.

Watch out for sentences that read 'Despite the . . .' or 'Except for . . .'as these are clues to problems. Other danger signals are the chairman spending too much time waffling on about the contribution from the management team, or omitting to say how trading has gone so far in the current year.

What's Next?

The chairman's statement should also give you an insight into the company's future. Does he say how the company will cope with or exploit the economic trends that it may encounter? Are there any changes in the company's different lines of business? Is management getting the company into good shape to weather any possible economic storms ahead? Is the company getting into too many areas that it knows nothing about in the name of diversification? Does it have a clear development plan? Does the chairman make a profit forecast? Is it realistic? Did he keep his word the last time?

The Figures that Count

Now, you can get your calculator and attack the numbers. The figures that matter are in the Profit and Loss Accounts and the Balance Sheet.

Source and Application of Funds

This is a relatively new financial statement and it sums up the net cash transactions of the year. It shows you how cash was generated, whether it was from operations or from other sources and how it was used.

You Have to Compare

One Annual Report with its chairman's statement and its financial ratios will not tell you much. You have to compare it with Reports of other years. Is the company's current ratio better or worse than in the previous year; than in the year before that? Is it better or worse than that of another company in the same industry?

Comparisons are the key to company-watching. They tell you whether a company is keeping up with the times, or sliding downhill. Stock analysts work out many more financial ratios to tell them how a company is faring. You can learn from them or from specialised books on the subject.

More Homework

The Annual Report gives you some basic information to gauge a company's health, but you must remember it is only a snapshot of the company's finances and is usually three to six months out of date.

Obviously you must do more homework if you want to know all you can about a particular company. Read the interim (half-yearly) reports which come from the company as well. Read, too, the financial press to see what they have to say about the company, its rivals and the industry they are in.

Next, keep up with business, economic and political news both here and around the world. All these will affect the company you are interested in, and, if you are well-informed, you will usually be able to make a realistic assessment of how it is faring in the current year.