With the numerous education books out there, I realise none actually teaches someone on how to read an Annual Report. This question struck me when I was teaching a friend on how to go about investing. We can break the investment process down into 3 steps. One, you have an idea. Two, you analyse it. Three, you decide whether to buy the stock. The hard part came when I was trying to teach the analysing part, which mainly consist of dissecting the Annual Report.
Every company is different. Other than telling them to read the Annual Report, what else is there to be said?
Read it more than once
It may seem rather duh that we should be reading an Annual Report more than once. However, what I meant is to read the whole thing straight through first. Reason being, by reading it straight through first, it forms the context in the next few reads. We have somewhat of an idea what the story is about before we start dissecting the nitty-gritty that we are interested in.
According to a recent interview, Corsair Capital's founder Jay Petschek did not plan to be a hedge fund manager. After holding various roles on Wall Street, Petschek decided to launch the fund in January 1991, when his family and friends were asking him to buy equities on their behalf. He realized the best structure for Read More
Of course, reading it more than twice is recommended as practice makes perfect. We will always miss something the first few times. After reading countless of Annual Reports, we would realise that there are certain few areas to zoom in to, saving us a lot more time.
Read it actively
One thing I believe in reading is that it should be done actively not passively. Armed with a pen and highlighter, we should be actively taking notes when reading an Annual Report. Notes such as ‘why did net profits drop so much’, ‘why is management taking on so much debt’ or ‘segment revenue breakdown’ should be jotted down by the side.
While the objective is always to buy undervalued companies, we have to understand the company and why it is trading at such cheap valuations. Understanding why net profits dropped significantly may give us some idea of the downward trending stock price. Furthermore, through reading countless of Annual Reports, by jotting down these notes, it would allow us to see similarities and differences between companies in the same industry. Key advantages that a company may possess or management seems to be hiding something is identified this way.
Undoubtedly, everyone has their own style. My method may not work for everyone, however, I believe it is a good starting point. I have seen some dissecting every detail, right down to the english used in the corporate governance act, I kid you not.
One thing certain is that reading your 100th Annual Report is easier than your 1st Annual Report. An Annual Report is like a book with its own plot and climax. Boring as it may seem, one has got to better learn to love it if they wish to be a better investor. Often, I would load up Annual Reports dating back 10 years on my iPad to accompany me on the plane trip to read.