Why Annual Reports Are Required Reading for Smart Investors

Given that we live in a time where information is largely fed to us by third parties, many investors might pass up an important piece of required reading, known as the annual report.Reviewing a printed booklet can seem so “old school” in this day of rapid fire, online information — maybe that’s the point.

But there are some benefits: reading it forces you to slow down and spend some time analyzing information that is highly relevant to securities you are investing your hard-earned money in.

If you aren’t a regular reader of annual reports, you need to become one. There’s information in them that isn’t always disclosed by the financial news analysts who recommend one stock over another.

What is the purpose of an annual report?

An annual report is a standardized document that is provided by most publicly traded companies. If you have the ability to read and interpret one company’s annual report, you will be able to do the same with others.

The annual report is a document that is prepared by the company, and it is written specifically for shareholders and prospective investors in the company. It provides information on the company’s performance in the most recent fiscal year, it discloses specific issues the company is facing, and gives some idea of what the future plans are.

Annual reports are available free of charge, since they are provided by the company specifically to inform and attract investors to their stock. You can get a copy of the report by calling or emailing the company (typically the shareholders services department), but they are usually readily available for download from the company’s website.

Note: Another part of required reading is the “10Q”, which is an annual report that the company is required to file with the Securities and Exchange Commission (SEC).

What you will find in an annual report?

Annual reports are typically presented in nine parts:

1. Letter from the chairman
2. Sales and marketing plan
3. A ten-year summary of financial results
4. Management discussion and analysis
5. CPA opinion letter
6. Financial statements
7. Description of subsidiaries, brands, and addresses
8. A list of directors and officers
9. The company’s stock price history

The importance of each of the above varies in importance. Some items (1 and 2) are what we might think of as promotional material. They’re heavy on opinion (usually positive in tone), but normally light on usable content. Others are history reports (3 and 9), and still others (6 and 7) are mostly lists.

The Management Discussion and Analysis (#4) bears close attention. This is where management discloses significant trends and challenges affecting both the company and the industry. It can help you to understand how the company is dealing with significant issues.

The CPA Opinion Letter (#5) is where the CPA firm who prepared the company’s financial statements expresses an opinion on them. This document can go either way — it can either reveal significant information that should never be ignored, or it can be more of a form letter.

If the opinion letter gives an “unqualified” or “clean” opinion (there are no exceptions) then it is primarily a cover sheet for the financials. But if it lists departures and references exceptions, you will need to get more information. To get an accurate analysis of the disclosures, you should speak with a CPA, or do some extra research on the web.

Financial statements are the most important annual reports.

The financial statements are the most important disclosures in an annual report. Primary among these are the income statement and balance sheet. There will be other statements as well — mostly subsidiary statements and schedules — but these are the big two, and the ones that you should pay the closest attention.

It’s important that you know how to read a financial statement so that you can properly interpret the information presented in these two statements. There could be significant information — positive or negative — contained in the numbers that isn’t showing up in any of the written summaries.

After all the analysts recommendations for or against a particular stock, you should never buy a stock — or pass on buying one — until you have looked at the annual report, and the financial statements in particular. And even if it’s a stock you already hold in your portfolio, you should still be combing through it’s annual report for as long as you own it.