Subject: Analysis - Annual Reports

Last-Revised: 31 Oct 1995
Contributed-By: Jerry Bailey, Chris Lott (contact me)

The June 1994 Issue of "Better Investing" magazine, page 26 has a three-page article about reading and understanding company annual reports. I will paraphrase:

1. Start with the notes and read from back to front since the front is management fluff.
2. Look for litigation that could obliterate equity, a pension plan in sad shape, or accounting changes that inflated earnings.
3. Use it to evaluate management. I only read the boring things of the companies I am holding for long term growth. If I am planning a quick in and out, such as buying depressed stocks like BBA, CML, CLE, etc.), I don't waste my time.
4. Look for notes to offer relevant details; not "selected" and "certain" assets. Revenue and operating profits of operating divisions, geographical divisions, etc.
5. How the company keeps its books, especially as compared to other companies in its industry.
6. Inventory. Did it go down because of a different accounting method?
7. What assets does the company own and what assets are leased?

If you do much of this, I really recommend just reading the article.

The following list of resources may also help.

• John A. Tracy has written an an easy-to-read and informative book named How to Read a Financial Report (5th edn., Wiley, 1999). This book should give you a good start. You won't become a graduate student in finance by reading it, but it will certainly help you grasp the nuts and bolts of annual reports.
• IBM offers guides to financial statements and annual reports in the investor relations part of their web site:
  http://www.ibm.com/investor/help/