Good information can help you make better investment decisions. There’s no doubt about that.
The trouble is, these days investors are bombarded with information. There’s simply too much of it. And the flow never stops. Newspapers, magazines, websites and TV channels all talk about companies and their shares.
But a lot of what’s written or said won’t help you much. That’s because the financial world and the media love stories. There’s a time and a place for stories, when you start researching a possible investment, what you really need is facts.
Thankfully, help is at hand in the form of one of the most valuable and overlooked pieces of information an investor can get their hands on. I’m talking about a company’s annual report.
Many professional investors are lazy
I’m going to let you into a secret: lots of professional investors think that annual reports are dry, boring documents. So much so, that they often ignore them.
In fact, when I worked in the City as an investment analyst, I was amazed to find that most of my colleagues didn’t read them.
I used to ask stockbroking analysts questions about them. A lot of the time they didn’t know what I was talking about.
The main reason for this – to put it bluntly – is that many professional investors are lazy. They talk to company management teams and analysts from investment banks, and they watch presentations.
But reading the annual report is too much like hard work.
That’s fantastic news for you, the private investor. If you have a company’s annual report and a broadband internet connection, then you have pretty much all the tools that you need to invest for yourself.
The fact that many professional investors don’t even read these reports can also give you a major advantage over them.
Getting the most out of annual reports
Annual reports contain a wealth of information for investors. They can usually be found on a company’s website. If not, you can write to the company requesting it, or you can go to the website of Companies’ House.
The great thing about annual reports is that they allow the diligent investor to build up their own opinion of a company.
But some bits of the report are more useful than others. Here’s a rough guide to which parts you should be paying attention to.
At the front of the report is usually a letter from the chairman and a review of the company’s results by the chief executive. By all means read these bits, but bear in mind that management teams often like to go on about all of the good things that have happened and neglect to mention the bad things.
If you do find words that indicate some humility or caution on behalf of the management, then that’s usually a good sign.
It’s also often a good idea to read several years’ annual reports. This shows you whether what the chief executive was telling shareholders about the company’s prospects a few years ago actually turned out to be true or not.
You can often learn more by reading the directors’ report. Here you’ll find out how many shares the directors own, and how much they are paid. It’s amazing how many highly-paid directors still own very small amounts or even no shares in the company they manage. If they don’t own many shares, then given that they should be best-placed to judge the company’s prospects, why should you?
More interesting still are the bonus schemes that are in place. Have a look to see if the rewards are excessive, or the targets to earn them are too easy. Many company executives get rich at your expense because of these schemes.
That’s because lots of them are based on growing earnings per share. This means the targets can be met by simply buying other companies or buying back the company’s own shares, rather than improving the returns on the company’s existing assets.
A relatively new and valuable part of an annual report in recent years is the statement of risks and uncertainties. You can learn a lot about a business by reading this.
For example, you can find out things like the reliance on certain types of customer or sources of raw materials or finance. This helps you to understand what might happen to a company if a certain event occurs. This might be something like the loss of sales if a major customer goes bust, or a boost to profits if a raw material falls in price.
Number crunching matters
But probably the most valuable part of a company’s annual report is the financial statements and accounts. Not only do you get to see the profit and loss account, balance sheet and statement of cash flows, but you also get pages of notes telling you how these are put together.
What is a balance sheet?
What a balance sheet is for and how you can use it.
It is this information which truly empowers the investor. By crunching the numbers in the accounts and reading the notes, you can go a long way to determining whether you are looking at a good investment opportunity or not.
To get the most value out of this exercise it’s best to get several years’ worth of numbers. You can then work out just how profitable a company is, whether these profits are believable, or if the company is in danger of going bust.
This may sound complicated and lots of hard work. It can be. But it’s also possible to get a lot of the answers you need, with only a few basic calculations. We won’t go through all of these now – we’ll deal with them in other articles.
What’s for certain though, is that if you take enough time to read and use the information in an annual report, there’s a good chance that you will learn things that others won’t.
And that can only help you to become a better investor.
• This article is taken from our beginners’ guide to investing, MoneyWeek Basics. Everything you need to know about how to invest your money for profit, delivered FREE to your inbox, twice a week. Sign up to MoneyWeek Basics here