Annual reports: What they can tell you about a company
Companies need to share heaps of information with shareholders and potential shareholders—it’s part of the deal when listing on an exchange. One way they do this is by releasing annual reports.
Annual reports are a detailed review of how the year went for a company. They have all kinds of information you can use for your due diligence, like how much money the company made, their strategy for the future, and who’s on the executive team. They’re also a way for you to follow the performance of companies you’ve already invested in.
Let’s look at some things to keep an eye out for when diving into a company’s annual report!
First up: where to find annual reports
You can generally find a company’s annual report on:
the company’s website (usually in a section called something like ‘investor’, ‘investor centre’, or ‘investor relations’
an exchange’s website (like the New Zealand Stock Exchange).
Now let’s get into what to look for. There are four main things: the numbers, the strategy, the risks, and the team.
There are a few notable numbers to look out for in financial statements. These include the raw details of the business—how much money they made, how much money they spent, how many assets they own, and a whole lot more.
The income statements show you how much money the company made (revenue) and how much they spent (expenses)—and what they spent that money on. They’ll also show you whether a company is profitable or not, and if it is, how much profit it’s making.
Of course, not all companies are profitable! Some companies deliberately choose to spend money on growth instead of profit. But either way, it’s useful to know whether they’re making a profit, and how large that profit is.
Cash flow statements
Cash flow statements show you how much cash a company has made, and where it’s come from—as well as where the cash goes. This is slightly different from income statements because income statements show you how much money has been promised. The cash flow statement shows how much money has actually gone into (and out of) the company’s bank account.
Balance sheets show you how many assets and how much debt a company has.
Assets include things like:
money in bank accounts
money owed to the company
property the company owns.
Debt includes things like:
money borrowed from banks
money owed to employees.
When you subtract the total value of the debt from the assets, you get the total equity. That’s the money the company essentially ‘owes’ its shareholders.
A good way to get some context around these numbers is to compare similar companies and benchmark them against one another. You can also compare these numbers to the same numbers from previous years, to get an idea of growth (or shrinkage).
You can find the company’s overall strategy in the letters from the chief executive officer (CEO) and Chair at the beginning of the annual report. If you want more detail, you can look to the investor presentation, which is a separate document that usually comes out around the same time as the annual report.
Strategy is important because it tells you what the company plans on doing in the future, and the tradeoffs it’ll make to get there.
How quickly does the company expect to grow?
Some companies might invest in fast growth at the expense of profit. This means less profit today, in exchange for a shot at much higher profits in the future.
Other companies might slowly and steadily grow, making higher profit in the short term, while sacrificing the opportunity to grow as quickly as they could have. Most companies will fall somewhere in between these two extremes.
How does the company plan to support growth?
A company’s plan to grow paints a picture of what it expects to look like in a year or more.
While some companies grow faster than others, almost all companies grow to some extent. Look at how a company intends to do so. Will it be expanding into new markets? Will it be finding ways to sell more things to existing customers? Will it be acquiring new businesses?
How will the company control costs?
Costs are another key part of strategy. Most companies look for ways to keep their costs down as they grow, and make sure they’re spending money on the right things.
Look at how a company plans on doing this:
Will they be restructuring?
Outsourcing some things?
Investing in new technologies?
An investment is, at its core, an investment in a company’s future. For that reason, it’s useful to know how the company plans on getting there.
Alongside the strategy for the future, you’ll also find an update on what’s happened in the past. It’s useful to compare this to earlier reports, and see how well it matches up. Does this company have a track record of doing what it says it’ll do? If not, what stopped it from doing so?
The other side of the strategy is the risks the company faces. You’ll also find these in the Chair and CEO letters at the start of the annual report.
Risks are a good counterbalance to strategy because strategy shows where the company sees itself in the future. The risks give you an idea of what kind of things may stop it from getting there. These two pieces of information can help you with your due diligence.
Finally, it’s useful to look at who’s in charge. Company reports tell you who is on the board, and who the top executives are.
These people are ultimately in charge of the company’s direction, and with it your investment—so take a look at their bios in the annual report. Go ahead and Google them too!
It’s useful to do this after you read about the strategy and risks. Once you have your head around the strategy, you can ask yourself if the management and governance teams have the skills to execute on that strategy.
Finally, you may want to ask yourself if the backgrounds of the management team are consistent with your values.
Corporate reports can be long and hard to decipher if you try to read them from front to back. By just focusing on a few key things—the numbers, the strategy, the risks, and the team—it’s a lot easier to get a general picture of the company. This information should help you make clearer investment decisions, without getting overwhelmed.
Ok, now for the legal bit
Investing involves risk. You aren’t guaranteed to make money, and you might lose the money you start with. We don’t provide personalised advice or recommendations. Any information we provide is general only and current at the time written. You should consider seeking independent legal, financial, taxation or other advice when considering whether an investment is appropriate for your objectives, financial situation or needs.