Reading a company’s annual reports is the fundamental pillar of every investment research process. The problem is that annual reports are often hundreds of pages long. This creates a huge barrier for new investors towards starting their investment journey.
Even if you’re an experienced investor, it's not easy to have the discipline to sit down and study these reports. Which is why people have a tendency to enter the stock market before doing their proper due diligence.
There's a shortcut to all of this, which saves you both time and brain juice. Zoom into the most important sections.
1. Read the “Business” section
Purpose: To understand the business model of the company
How does the business make money?
What products/ services do they sell?
Who are their customers?
2. Risk Factors
Purpose: What are the risks of that the company might face?
What can go wrong?
Many people only look at how much money they are going to make when making an investment purchase. It is imperative that you protect your downside before looking at the upside. Ask yourself what's the worst that can happen.
3. Read the “Management Discussion and Analysis” section
Purpose: To understand management guidance for the business
What are the recent operating results of the business?
What is the direction of the business going forward
4. Use the financial statements to come up with a valuation of the company
Purpose: To assess how much a company is worth
There are 3 types of financial statements:
Income statement/ Profit and Loss Statement
Balance Sheet/ Statement of Financial Position
Cash flow statement/ Statement of Cash Flows
What items to look out for:
Operating cash flow (Cash flow statement)
Cash and cash equivalents (Balance sheet)
Long term debt and short term debt (Balance sheet)
All the figures can be taken from the financial statements, with the exception of the growth rate. Estimating a company's growth rate can be a tricky, and often futile task. One way to do this is by looking EPS next 5Y on finviz.com
EPS for next 5Y gives us an estimate of the annualised growth rate of the company over the next 5 years.
These are the 4 sections in the annual report which you can use to guide your investment decisions. While this might not the best way, it helps to remove the hurdle when it comes to getting started. It’s a good way for busy (and lazy) people to be more focused, instead of going through hundreds of pages of reports and retaining nothing.