January 6, 2023
Information might be the very best tool for any retail shareholder. But as any individual investor knows, good information is hard to come by. Much of the information available to individual stockholders is tainted by the writer’s biases and opinions. Facts can be hard to come by.
That’s why a company’s annual report is one of the most important documents that a retail investor can use to vet the health of a corporation and where it is headed in the future. Annual reports are barometers of corporate health. So as a retail stakeholder, what are annual reports and what should you look for when reading them?
Annual reports are publications that public companies are required by law to publish each year that describe the companies’ operations and financial conditions. They are great tools for individual investors because they contain detailed information on the companies that allows current and potential shareholders to make informed investment decisions.
Annual reports can trip up investors – especially inexperienced shareholders – who can get bogged down in the legalese and sheer volume of information found in the documents. In fact, for the average retail shareholder, 90% of the annual report consists of detailed information you won’t need to make smart investments.
Annual reports are a bit of a briar patch since the other 10% or so is pure gold. The trick is being able to sort through the chaff for the truly important information.
The typical annual report is split into two sections. Most individual investors will probably get the most important information out of the first section, which includes a written description of the company’s performance over the course of the year in the form of letters to shareholders from the chief executive officer, chief financial offer and other top executives along with graphs, charts and photos that help explain the financial strengths and weaknesses of the company.
Annual reports are important because the information is unvarnished; different information than the press releases and other marketing materials released by the company. The annual report includes all the dirt, both good and bad.
The second half of the typical annual report is even more sterile than the first – a collection of financial documents and statements without any of the narrative.
An annual report is a document designed to be sent to shareholders every year before an annual shareholder meeting and election of the board of directors and they typically consist of:
Letters to shareholders: Annual reports often include a shareholder letter from the CEO or president and other top executives that provide a broad overview of the company’s activities and performance over the course of the year, as well as a reflection on its general business environment.
Management’s discussion and analysis (MD&A): This section includes a detailed overview and analysis of the company’s performance as outlined by its executives.
Audited financial statements: These are financial documents that detail the company’s financial performance. Typical statements include balance sheets, cash flow statements, income statements and equity statements.
A summary of financial data: This data is used to highlight financial statements included in the annual report.
Auditor’s report: This describes whether the company has complied with generally accepted accounting principles (GAAP) preparing its financial statements.
Accounting policies: An overview of the policies the company’s executives used to prepare the annual report and financial statements.
You don’t have to be a shareholder to access an annual report as they are often found on the company’s website and can be easily downloaded. As a shareholder of the company, it will be automatically sent to you for your review.
An annual report is different and should not be confused with a proxy statement. A proxy statement is filed when a company is looking for shareholder votes prior to an annual meeting. Proxy statements, called a Form DEF 14A, includes new board of director nominees, executive salary and compensation and other issues that might come before the board for a vote. An annual report is different from at 10-K Report as well, though both continue similar data. 10-Ks are created using SEC guidelines and include all a company’s fiscal activity, corporate agreements, risks, opportunities, operations, executive compensation and market and industry analysis.
From a financial standpoint, retail shareholders reading an annual report should focus on a few sections: the balance sheet, income statement and cash flow. It is also important to read between the lines. Individual investors can get a sense of what’s happening at a company through an annual report by reading not only what a company mentions, but by what it leaves out. Companies sometimes bury controversial items deep in annual reports. Look out for those items as well.
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