| There are rules and there are practices. Sticking to rules doesn't always reap dividends if the basics are not mastered. Investors should first go through a company's annual report before deciding to pick up a particular stock, yet because of lack of clarity or ignorance it is often skipped. Not realising how important the document is, we overlook the purpose for which the report is prepared — satisfying the information needs of stakeholders, potential stockholders, creditors, financial analysts, economists, customers, suppliers and the promoters themselves. To help you through the maze, here's a lowdown on keys to reading an annual report — which serves beyond a performance report card. WHY READ? Referred to as a "starting document" for investing, a company's annual report carries the management's future outlook and vision for the organisation. It not only gives a peek in to the company's operations but also a perspective on its financial health and broad strategies. Regarded as an investment thesis based on past deliverables by the management, the report contains detailed information that is typically not elaborated in general discussions about the company. Since the report contains insights on the company's operational methodologies, analysts advise you should do your detailed study to identify the company's core competency and form an opinion on whether the firm can sustain in competitive environment. This exercise would help you ascertain if the company would be able to fuel its expansion plans through sufficient funding without diluting its stake. Annual report, however, should not be the only criteria to form an investment decision. There are other sources of information too, which one should supplement with the annual report study before deciding to invest in a company's stock. Because of the difference in the quality of management discussions and disclosure, annual reports are usually not consistent across companies. CONSOLIDATED VALUE Unlike annual results, quarterly results are not accompanied by balance sheet numbers and cash flow statements, while review from the independent auditors is optional. Therefore, it becomes difficult to assess the strength of the company by only looking at its quarterly result. Another area where an annual result scores over a quarterly result is consolidated reporting. Since companies have an option not to disclose 'consolidated' results for the first three quarters, it does not capture the impact of consolidation. "Many a times, performance of the subsidiaries have a significant impact on the overall financial health of the company. Quarterly numbers are usually unaudited and therefore one cannot always completely rely on the numbers," says Chetan Majithia, head of equities at Crisil. An annual report, analysts recommend, ideally should be read in conjunction with subsequent quarterly results to get a more holistic picture. "Although the quarterly results have disclosure limitations, it still serves as a periodic check on company's performance and helps prevent significant surprises for investors at the year end," says Anupam Kumar, associate director, Walker Chandiok & Co. Quarterly results allow you to analyse whether the management is delivering the promises mentioned in the annual report. If they are not, then you can exit from the stock without waiting for the annual report to come at the end of company's financial year. KEY SECTIONS Though all sections in an annual report are considered useful, most of the analysts advise one to start by reading the management discussion and analysis section to get promoter's viewpoint on the state of the industry,challenges, their performance and strategy in the developing business environment. This will help you focus on the company's operating ecosystem along with the vital performance benchmarks that may be used to develop a basis for future expectations. Next in order should be a thorough review of the financial statements — balance sheet, profit & loss account and cash flow statement. In case the company has subsidiaries, both standalone and consolidated financial statements should be studied. Schedules and notes provided at the end of cash flow statement is another area you should examine in detail. These notes include vital information like future legal liabilities, contingencies, non-operational income disclosures, forex losses, and loan schedule, which disclose claims and contingencies of the company. "Cash flow statement is an indicator of a company's financial health. It reflects the flow of cash for the year," says Karan Chimandas, assistant vice-president — research and financial planning, Pioneer Investcorp (PINC), Mumbai-based stock broking firm. Then there is the auditors' statement which should be thoroughly reviewed to see if there are any qualifications or issues of materiality which can impact the company's reported picture. The section on management profile, board of directors and change in their shareholding pattern in the corporate governance section of the annual report also provide useful facts that may have a bearing on the future direction of the company. However, before making an opinion on the materiality of the item affecting the company, you must understand the nuances of the industry. What may be material in a particular company, may not be so relevant in other company's case. Majithia cites an example of history of litigations in pharma companies which is quite common and therefore may not be very material. "However, if a company in the service industry is repeatedly involved in litigations, then it may be a sign of concern," says Majithia. It is said that there are no shortcuts to becoming a successful investor. And annual report analysis covers a lot of ground work required to make investment decisions. Make sure you recognise the pertinent facts from the glossy presentation! Source: ET |
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