They show how strong companies are financially and the direction they are headed, details that can help you make investment decisions
It is that time of the year when annual reports of companies find their way to investors by e-mail or snail mail, or both. Average investors, however, pay very little attention to the reports, which are the most critical and exhaustive communication from companies to their investors.
In most cases, the fat reports are disposed of with old papers, without being opened, or are consigned to the recycle bin if they are received by email. According to investment experts, this is not the best practice for smart investors.
An annual report can tell you a lot about the company you have invested in: it will inform you how the company has performed in the year that has gone by and offer some idea about the direction it is headed in the coming year or near future.
In fact, for an average investor, the annual report is the only financial document they get from the company. Sure, one would have tracked news about the company on television or newspaper. Or read experts' take on the quarterly results of the company. However, the fact remains that the annual report is the only document the company is obliged to send to its shareholders.
It is said the devil is in the details. When one selects stocks, in addition to looking at the business, management and valuation, one needs to take a close look at things in the annual report — balance sheets, income statements and cash flow statements.
DON'T GO BY PHYSICAL APPEARANCE
Don't be fooled by the design, look and feel of the annual report. Companies are free to design annual reports in any way they want. There is no rule that specifies the number of pages, the shape or size, or the quality of production and so on of an annual report. While some balance sheets are thick and run into hundreds of pages, some may be lean. Some companies come up with plain vanilla annual reports with simple fonts, and pay little attention to page layouts and displays, while others use high quality paper and lay great emphasis on design to ensure that the annual report is pleasing to their shareholders.
Investors should never get carried away by the physical appearance of the annual report. They should rather focus on how much information it contains.
MANAGEMENT DISCUSSION AND ANALYSIS
While you savour those glossy pages, don't get enamoured by them. What matters are the details in the section where the company shares its views on the direction the company plans to take, how it thinks the year ahead is going to be for the industry and how the company will fare — in short, things that will help you make investment decisions.
While there are some companies who do have meets and conference calls for analysts regularly, some others are not so forthcoming. For example, some multinational companies share very little with analysts even if they are kind enough to convene an analysts' meet.
It is a quick SWOT analysis and gives us everything at a glance. If investors can read the previous year's discussion together with this year's, it would give them a better indication of the management's quality.
Also, it would be very difficult to get facts and figures about certain industries as there may be only a few companies operating in the sector. If a company is into managing e-waste or recycling, one would have to rely even more on management discussions to get an idea about the company.
FINANCIAL STATEMENTS, BALANCE SHEET
Spend a few moments on this section, which contains the most crucial numbers concerning a company. It gives you clues about the financial strength of the company. Look at the profit and loss account and income statement, as they will tell you how the company is performing — how much profit the company is making and what its earning are from core operations.
In a rising interest rate scenario, I would look at the debt on the company's books. This is because profitability is bound to come down when interest cost goes up. He also looks at things like international currency loans, as there is a currency risk involved there. Then there are things like inter-group loans, investments.
Things like debtor days (which indicates how quickly cash is being collected from debtors) and inventory are not there in the quarterly results. Hence, one needs to look at them carefully in the annual report.
Another important item is loans and advances to group companies. If a loan has been given to a subsidiary company without charging any interest, it has to be justified
Then there is the crucial auditors' report. In most cases, it will state that the profit and loss account and balance sheet give a true and fair view. However, look for cases where they tell you if the management has been up to things that are unacceptable or has used unethical accounting practices.
Then, there are notes to accounts. Take the example of BHEL. In its results declared this year, BHEL has modified the accounting policy on employee benefits in respect of leave liability. The impact due to the change in the accounting policy for the year 2010-11 is an increase in profit before tax of . 240.8 crore.
OTHER THINGS
In the case of manufacturing companies, analysts find it interesting to take a look at the production figures and the installed capacity to get an idea of the efficiency level of the company. There are analysts who look at items like related party transactions, salaries and perks paid to key managerial employees and ESOPs issued during the year. One could look at the number of independent directors in the company, to understand the strength of its board, and check if there are some eminent personalities. Some annual reports also have a summary of the 10-year financial summary, which gives you the growth in income and profits at a glance.
Lastly, the annual report also has the attendance slip form, which gives you the right to attend the annual general meeting (AGM) — making a trip to the AGM and see the top management in action would give you a first-hand experience of the company.
