What is an annual report?
Annual reports are documents filed by public companies that describe the state of operations and financial conditions of the business for the previous year.
Reading annual reports is important because it allows those who are interested in investing in a stock/company to get a very good understanding of the business, its operations, its strategy, the market, and its financial results among other important information.
This is the same reason why Warren Buffet, one of the best investors of all time, reads one report per day. Sophisticated investing starts with understanding the business you are trying to invest in, and a company's annual report is the best starting point.
Once you understand the business well you are in a much better position to make a wiser investment decision.
Where can you find company's annual reports?
The best way to find a company's annual reports is to search the name of the company on Google followed by 10K or 10Q report. For example, "Apple 2020 10K report". It's likely the Securities and Exchange Commission will be one of the first results if not the actual PDF, either one is a great way to access the report.
As for 10K's and 10Q's, the difference between them is that the 10K report is the annual report whereas the 10Q is the quarterly report. 10K's are generally more comprehensive with a good overview of the business, its market, its business model, the risks, and its financials.
Components of an annual report
Company's annual reports are mandatory for public companies to file every year. These reports typically contain the following information:
- Company background and general information on the business
- Risk factors
- Operating and financial highlights
- Letter to the Shareholders by senior management
- Management's discussion and analysis (MD&A)
- Corporate governance information
- Financial statements such as the income statement balance sheets and cash flow statement
- Financial statements notes
- Accounting auditor report
- Accounting policies and summary of financial results
The 10K form of the annual report allows investors to easily browse through these sections by clicking on them in the table of contents.
How to read annual reports
Step 1: Find the table of contents
The first thing you should do when reading an annual report is navigate to the table of contents. In this section you will find the categories and types of information the annual report includes. The benefit of this step is rather than reading the whole report, you can focus on those key areas that are going to impact your investment decision.
Step 2: Read the business section
Even though you can begin your reading with any section, it is highly recommended you get started by reading the business overview. In this section, you will get a better understanding of what the business is about and the market in which it operates. Keep in mind, the more you understand the business and its market, the more likely you are to make a better stock investment.
Step 3: Read the risk factors
No investment is without risks and the risk factor section is a great reminder of that. This section often includes obvious risks like industry regulation. It is important to focus on the risks that are not obvious, that are likely to happen, and are very impactful when it comes to the long-term performance of the business.
Step 4: Read the financial statements and management discussion analysis.
The company financials are without a doubt one of the most important aspects of the annual report. A company can say very positive things about aspects of its business, but the financials often reflect whether that is true or not.
The most important part is to read the audited financial statements, including the income statement, balance sheet, and cash flow statement. The audited statements are best because they are audited by a third-party accounting firm that ensures the reliability of the numbers and accounting methods used.
For more detail, check out our other posts on each of the financial statements and what to look for in them.
After you read the financial statements and look at the footnotes made by the company one of the best things you can do is to go deeper into those numbers and use Wisesheets. This allows you to get the financial statements and key metrics on your Excel spreadsheet for the last 20 years.
This is a really helpful strategy because it allows you to analyze different key metrics such as the historical PE ratio, price to sales, inventory turnover, ROE, as well as many others that allow you to better assess the value of the company.
You can also use the =WISE function for when you do your DCF model. Once it is set up, you can run it for every company you’d like without having to waste time copy-pasting the financials.
What comes next after reading an annual report
After reading the annual report it is recommended that you do other external research to better understand and address any questions you may have in regards to the business. For a detailed guide on other important factors to research follow this post.
Once you have a strong understanding of the company it’s time to make your investment decision. Buying or waiting for the price to drop should be a logical decision made based on what you think the company is worth versus what the market says it’s worth. If the company’s market value is below what you think the value of the company is, and there is a margin of safety to support you in case your estimates are a bit off, then that’s the perfect time to buy. If not then it’s best you put that stock on your watchlist and assign a target price to it so that if it drops below the price you set, you can buy it.
If you want to learn more about how you can get stock financials, key metrics, and growth metrics directly on Excel or Google Sheets in seconds, check out www.wisesheets.io
To your investing success,
The Wisesheets Team