Reading annual report is tiring task it might take 2-3 hours to read one completely. To do equity analysis investors have to read number of such reports of number of companies.
But not all content in the annual report is useful for the investor. Many things are just for compliance purpose which have nothing to do with the business. In order to grab useful information only, in timely manner investor should separate the text that is not necessary for fundamental analysis of company.
In this post we will see what to consider and what to ignore to get necessary information in clear and concise and timely manner.
Corporate Overview/ Financial Highlights
This is the beginning of annual report it contains lot of graphs and bar charts of revenue financial statement figures and ratios like ROI and ROE.
This part of annual report shall be completely ignored. There can be lot of pictorial and graphical manipulation of things, only factors that are in favor of company are shown here, which created biased positive view about the company . All the information given here can be analyzed from Financial Statement section of annual report.
Steepness of the graph, height of the bars, preference of normal over logarithmic chart can create illusions .
Chairman’s Letter
Mostly written by HR but then also give insight into what person at the top thinking. But not to believe all future possibilities that key management person tell because they sometime try to sell company to investors with wrong assumptions.
Example:
Management of Manpasand Bevrages by giving reason of rural penetration assured investors that their mango drink will be one of the highest selling mango drink in country. A position where Frooti (highest selling mango drink in India) took 20 years to reach.
As an investor we should not believe terms like weak competition, strong business model, unique business strategies blindly we should find for strong evidence of convincing theory behind it.
Read about | The Curious Case of Manpasand Beverages.
Directors Report
There are some things which are important here.
- Declaration of dividends.
- Raising of new capital.
- Summary of Employee stock option plan.
- Expansion projects .
Some Unimportant items .
- Energy, Technology and foreign Exchange.
- Cautionary Statements .
- Compliance under Companies Act, 2013.
- Human Resource.
- Corporate social responsibility.
- Financial highlight can also be ignored as it can be covered in Financial Statements.
Management Discussion and Analysis
One of the most important part of annual report other than Financial Statements. Topics discussed here are future outlook of industry, future business strategies of company, advantages and threats of businesses, business model with major segments based on products of geography. All the things are necessary to get understanding of company.
(One way you can check competence of management of businesses is to look for the promises made by them. Like increasing production capacity, building new plant and strategies that management have discussed, revenue and profit expectations in the past annual reports and then crosscheck in same section in present annual reports whether they are executed or fulfilled.
If management is doing what they are saying then it is good signal.)
Shareholding Pattern
Shareholding pattern section gives complete knowledge of how much stake management hold in the company. If CEO MD has no shares in the company then they may lack incentive to work for value enhancement of shareholder and more incentive to just increase their compensation.
We can also know which institution hold shares in company. Changes in shareholding is also crucial factor to track.
One thing is not in the annual report but should be compare with shareholding is Percentage of shares pledged . This can be obtained from searching on Google because it is mandatory to file this information with Exchanges and SEBI.
Share Prices
Trend in price and comparison with the index can be distracting while doing rational fundamental analysis.
Audit Report
There is nothing much to gain from here, as there are very few cases where auditor openly talk about inconsistencies in company as they might lose their client. One paragraph is important which is “key audit matters” it contains points which are important from the perspective of auditor which auditor wants readers of report to pay attention.
Mostly matters stated here are
- Difficulty auditor faced to evaluate assets.
- Assumptions made by management in revenue reorganization process.
- Contingent liabilities.
- Non surety regarding to valuation about any assets.
Financial Statements
Most important part of annual report investor should spend most of the time to read this part.
Many investors ignore notes to accounts and read main financial statements only which is wrong approach because many times figures can be misleading and over viewing data can give half picture.
So in depth fetching of data is must.
Notes given after financial statements which states how annual reports are prepared i.e How are items in financial statements are calculated what are assumptions which process is followed while calculation should be read very carefully .
Many prefer to first read notes to accounts and then main financial statements this method is best for those who ignore notes when they read financial statement.
Consolidated or standalone financial statement :
It is better to consider subsidiaries as the part of business rather than just an investment. In case of Reliance if we consider Jio is just an investment and not a part of conglomerate. So if profit from subsidiaries are significant or asset investment is significant then one can skip standalone financial statement .
Contingent assets and liabilities
Contingent liabilities contains mainly litigations running against company, claims that company may have to pay in future. Abnormally high contingent liabilities can bring threat to business in the future.
There is no fixed section for contingent liabilities in annual report. But most of the time it is after the schedules or notes to accounts.
Sections one can skip with no information loss.
- Notice : which directors are retire by rotation with special resolution to be passed in annual general meeting . Information about the directors to be appointed and compliance regarding to that . One may not get much so recommended to skip as educational qualification and other such information may not tell about management and business skills .
- Internal auditor report : Should be skipped as there is no independence in auditing
- Corporate governance report : Corporate governance policies cannot overcome integrity and intention of management so no matter how many committees they make how there much their presence is there in meetings this are not worthy factors. Only remuneration figure is important. Compare this figure with competitors of company with the help of Profit before tax to remuneration figure more ratio than other players in an industry is good.
- Disclosure in director report
- Business responsibility report.
- Annual return extract .
Many times investor read overview in director’s report and skip Financial Statements as it take very much time or some investors only read financial statements and skip all other sections in annual report.
Both the approaches are incorrect this gives half picture of company which can lead to incorrect investment decision making.
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