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How to read a corporate financial report

PSA is developing an autonomous truck platooning system to alleviate the trucking manpower shortage, while ST Engineering is producing VIP jet cabin interiors with 3D printed parts. And Boustead is delivering geo-spatial and mapping services to help Australia’s Department of Defence.

Annual company reports can be more interesting and easier to read than many people think. Look for ‘red flags’ in key areas and skim the rest, say advisors. Photo: Reuters

Annual company reports can be more interesting and easier to read than many people think. Look for ‘red flags’ in key areas and skim the rest, say advisors. Photo: Reuters

PSA is developing an autonomous truck platooning system to alleviate the trucking manpower shortage, while ST Engineering is producing VIP jet cabin interiors with 3D printed parts. And Boustead is delivering geo-spatial and mapping services to help Australia’s Department of Defence.

During the past several months, investors have received a flurry of corporate annual reports that contain fascinating details like these, and in the coming weeks there may well be a slew of quarterly updates.

Even though annual reports and company announcements might seem unexciting, some investors pore over them to find valuable insights and decide whether to buy, hold or sell shares. The reports can actually be more interesting and easier to read than many people think.

READING THE ANNUAL REPORT

The concept behind company reporting is straightforward.

“Annual reports’ financials tell investors how a company has been faring, and what are its future plans,” said Mr Kenny Lo, head of retail equities, at Maybank Kim Eng Singapore. The annual report also has “important disclosures, like the company’s future direction and business strategies, which will enable the investor to reassess his investment decision”, added Securities Investors Association Singapore (SIAS) president David Gerald. If you think a company has great growth prospects, for instance, the annual report can show whether it is actually growing, with rising revenue and profits.

Given how long annual reports often are, it is important to focus on key areas in order to find the nuggets that really reveal how the company is performing. Investment advisory firm Kiplinger says you do not have to read every word. In fact, it said, “smart investors focus on a few key sections for red flags — and skim the rest”.

Fidelity Investments’ head of global equity research, Christopher Bartel, told CNBC that management discussions are where the company talks about everything from financial requirements and risks to strategies. “You start to put together how the company works,” he said. If something about the firm’s finances strikes you as strange, such as cash dropping or sales stalling, this section should tell you why change is happening.

Cash flow is especially important, sometimes even more than profitability, in figuring out whether the company will thrive or dive. Now-bankrupt WorldCom reported tremendous income growth, for example, even as it lost huge amounts of cash. USA TODAY financial reporter Matt Krantz advised investors to compare cash flow with net income. “Cash is cash, and this line item is particularly important in fundamental analysis to assess when making investing decisions,” he said. “You want to make sure that the company is bringing in roughly the same amount of cash as it reports as profit.”

Mr Krantz also advised looking at operating and gross margins. While many investors get overly consumed with a company’s bottom line, he said, the profit a company generates should also be compared with its revenue.

The auditor’s report is important primarily if there are any red flags. In most cases, the auditors simply say that the financial statements accurately represent the company’s financial position. If they say something else, it is an alert for problems at the company.

“The annual report will also highlight risks of the company which need to be managed,” said SIAS’ Mr Gerald. Astute investors may also read between the lines to see if a company omits disclosing risks that could cause the share price to drop, such as not mentioning that lower oil prices could impact oil rig sales, or that property price drops could affect mortgages.

Maybank Kim Eng’s Mr Lo also noted that the return on equity and return on assets ratios tell you if a company is using resources efficiently for growth and help you compare companies of different sizes in the same industry. Additionally, he said: “Dividends show whether shareholders are being rewarded.”

Finally, take a look at the CEO’s salary. While it is worth paying a lot if the company also makes a lot and shares go up, an excessive salary could be a sign that top management is looking out more for itself than for shareholders.

Along with annual reports, some companies also send out half-yearly or even quarterly reports, as well as announcements when something unusual happens. These short reports are important too, so you can figure out whether something has changed that would cause you to buy or sell shares.

USING ANNUAL REPORTS TO INVEST

After reading the report and focusing on the key areas that matter most, investors should put it all together and use their informed picture of the company to decide whether to invest or continue to hold shares. If management’s strategy looks sound, cash flow is positive, and ratios and margins are good, the company may be a sound investment. If those indicators are not positive, or if the audit report or risks have a red flag, it can be better to invest somewhere else.

Spending just a little time reading the annual report even just once a year, focusing on the crucial parts and skimming the rest, can help the average investor gain insights into the company that can position them well for a profitable future.

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