Getting The Hang Of Reading Annual Reports

Foreword from ShareInvestor

This article “Getting The Hang Of Reading Annual Reports” by Goh Eng Yeow was first published in The Straits Times on 20 Apr 2014 and is reproduced in this blog in its entirety.

Be alert to big drops in sales and/or profits, jumps in debt levels and queries from SGX

Like thousands of other investors, I have found my mail-box cluttered and overflowing with annual reports in the past few days.

Most of these reports are mailed in the form of CDs but there are a handful of companies that still take the trouble to send me the printed copy.

I try to make the effort to go through the annual reports when I find the time. Most are from companies whose shares I have held for years and reading their reports reinforces my belief as to why I bought them in the first place.

But I am more the exception than the rule in this respect. Few investors bother to even glance at the reports sent to them. In fact, most people I know toss them away unopened, even though the companies might have spent a lot of time painstakingly piecing the information together.

The problem may have become more acute in recent years because the reports come in CD form. Trying to manoeuvre through a report on a laptop can be an ordeal compared to flipping through the printed copy.

That said, I understand the need for companies to be environmentally friendly and save the forests by using less paper since most of the reports end up in the bin unopened anyway.

When I ask friends why they fail to look at the annual reports of the listed firms they invest in, the same excuse crops up again and again: They don’t have the time and they don’t know what to look out for anyway. They also rely on their brokers to tell them if anything is amiss.

That is a pity. Unlike buying a house that you can see and touch, holding listed shares is a peculiar form of ownership in a company. You have no direct control over the firm’s assets and you reserve the right to walk away at the drop of a hat by selling your shares.

So, next to attending the company’s annual general meeting to size up its management and form an impression of where its business is headed, the next best recourse is to take a stab at its annual report.

But the problem is that annual reports are not exactly easy-to-read documents to start with. Most of them are dense and dull, run to a few hundred pages and are filled with lots of off-putting numbers. Some do not bother to have pictures to liven up the grey pages.

However, it is important for a long-term investor to try and understand how the business of the stock you own is performing, and one of the best ways to do that is by going through the annual report, whether you like it or not.

I have some suggestions on what to look out for if you have only a few minutes to spare:

What Is The Management Saying?

There is nothing that beats reading the top dog’s take on the company. In most cases, the chairman’s statement is merely a bland overview of the company’s past performance – with highlights of any achievements, such as an increase in dividend payouts.

However, if an investor owns shares in a particular company long enough and he takes the trouble to scan the annual reports, then the tone of the chairman’s letter and management discussion will be a good pointer to how the core business is running.

If the management starts making excuses or talking in jargon, that should ring alarm bells.

Sales, Cash Flow And Debt Levels

You do not have to be a sophisticated investor to know that a big drop in sales and/or profits is a sign that all is not well with the company. Other red flags would be a sudden drop in the cash flow a company gets from its operations. I usually also check to see if there is any big jump in the company’s debt levels.

What you should also do is to check the Singapore Exchange’s (SGX) website to see if it has raised any queries with the company after it issues its annual report.

The additional information the company has to disclose following an SGX query will often give you a handle on how its business is performing.

Auditing The Auditors’ Take

A listed firm must hire an independent auditor to run his eye over the financial numbers it releases in its annual report.

For most companies, it is routine to get a clean bill of health from their auditors, but there have been instances of auditors flagging their concerns over a company’s financial conditions which an investor needs to be aware of.

If a company is changing its auditors, that may also be a cause of concern. You can check the disclosure the company would have made to the SGX for the reason for the change.

At the end of it all, the money is yours to lose if you fail to keep abreast of developments in the company whose stock you own. So those few minutes checking out the report could turn out to be the best investment you make.