Annual Report Purpose – And how to read one

Investing in stocks requires thorough research. Since we are investing in a business, the more we know about it, the stronger conviction we can build around holding its stock. It is here that the annual report purpose comes into play.  While in the internet era there are plenty of ways to carry out stock research, the most effective way is to read the annual report of the company. The AR released every year encompasses the company’s efforts and in an extensive 200-300 page report. The sheer magnitude of the quantity of content may make it cumbersome for you to go through it. Hence, a helpful way of reading an AR is to compartmentalize the possible takeaways. It will help you keep an eye out for specific information without losing yourself in the sea of content.

Business Update

This category should help you with all insights around the tangible business being done by the company. It would include the following.

  • New products – If the company has launched any new and exciting products in the market which could be game-changing
  • Performance of Divisions– Which divisions and acquisitions of the company have been doing well and which ones are possible liabilities
  • CAPEXCapital Expenditure i.e how many fixed assets the company is investing in which could become sources of cash flow in the future.
  • Margin Fluctuation- A company may be raking in high revenues. But it is important to find out if its margins are big enough for profits to be realized.
  • Industry updates– How the general industry has been performing and where the future scope lies. Also take crisis into account, such as the housing bubble of 2008.

Management Updates

This includes information about who is running the company, what is their vision and how efficiently are they running the various aspects of the business.

  • Change in Board– Whether any new individuals have taken over and whether the vision and goals of the company have changed
  • Promoter Holding- Whether the management has skin in the game. Having a sizable investment in the company ensures they take decisions that would always benefit the company

Financial Analysis of an annual report

– Last but not least, thoroughly examining the numbers of the company in the annual report. The narrative and stories are baseless without numbers providing the support. The three main accounting statements should be analysed.

  • Income Statement– This tells us about the top line of the company. How much revenue the company has been earning and what their margins are on the revenues earned. A company with steady growth in revenues is one to watch out for.
  • Balance Sheet– It is important to ensure that a company isn’t expanding its balance sheet by taking on too much debt. Debt can finance a lot of projects and help the companies grow faster. But if it becomes too much for the company to handle, it could lead to doomsday. Having debt lesser than reserves is always a safe sign.
  • Cash Flow Statement- Probably the most important statement. The cash flow statement conveys whether the company has cash in hand to grow its business. Often profits are utilized in paying off debt or running day-to-day operations. Having free cash flow ensures the company can invest in high-growth projects. It can even reward investors with dividends which build investors’ trust.

A good understanding of these various aspects will certainly help you find good companies. And also build conviction in the ones you are already invested in. In short, this is the annual report purpose.