Why Read an Annual Report:
Effectively analyzing the annual report is an essential component of stock study and is absolutely necessary in performing complete research of a stock.
The analysis will help in making judgement decisions about the company.
Analyzing the annual report combined with completing the Stock Selection Guide and library or online research on the company are the best ways to analyze the performance of a company.
Purpose of an Annual Report:
At the end of each fiscal year, companies publish a report to inform stockholders about what has happened during the past year and what is expected in the future.
This must be distributed to shareholders under Federal Law.
There is no standard to which all reports comply but Federal Law requires annual reports to contain certain information and financial data about the company.
Companies have a lot of latitude in determining how data will be presented, how much is presented, and what they say about past and future performance.
Most report financial highlights for two years performance although some may give up to ten years of figures.
Major Parts of an Annual Report:
This section includes 5 important areas.
The Balance Sheet
This shows what the company owns which are called assets and includes properties and accounts and what the company owes which are called liabilities and includes debts and claims against the company. It shows the assets and liabilities that a company has at the end of the fiscal year.
You can evaluate the company's solvency, or ability to meet its debts, by studying the balance sheet.
It is a balance sheet because it shows both sides of a company's financial condition. On one side are the assets. On the other side are the liabilities and the shareholder's equity. These two sides should always be equal. The Formula is: Assets = Liabilities + Shareholders Equity
Note: The difference between assets and liabilities is called the shareholder's equity.
The Income Statement
This is also known as the Profit and Loss Statement.
It shows how well a company performed during the period presented and shows if the company's operations have resulted in a profit or a loss.
It shows cost, income, expenses and profit/losses.
This is basically Section 2A of the Stock Selection Guide.
The Statement of Shareholders Equity
Shareholders Equity represents the ownership of the company. Companies may issue common and preferred stock.
This shows what is leftover after subtracting the liabilities from the assets.
Changes in shareholders equity are usually the result of company profit or losses, dividend payments, and stock transactions.
Stockholders are the owners of a company while bondholders are creditors of the company.
This is basically Section 2B of the Stock Selection Guide.
The Statement of Cash Flow
Reports on the company's cash movements during the period separating them by operating, investing and financial activities.
The Notes to the Financial Statements
Addresses "what's going on with the company". Pending lawsuits or accounting procedures can be listed here.
Read the notes carefully.
If there are problems in the company, the notes may be where they will be uncovered.
Important information about litigation, unusual liabilities, new pension or stock option plans, and other news not found in other sections will be here.
Look for the auditing firm's certification in this section.
Check the auditor's opinion to determine if this is a routine approach or only a qualified endorsement.
If the latter, the reasons for any reservations are important. Further inquiry is needed.