MyValueResearch

Listen What The Annual Report Says!!

For choosing a valuable stock in the stock market, the financial aspect of the company plays a very vital role. The annual report can be of great support in choosing the right king among the stocks to invest. All substantial information is provided in the annual report through which the companies keep their shareholder’s updated about its fiscal health. As per the rule every listed company is supposed to issue all finance related information to the shareholders be it the financial results or the proposed investments in any other venture. It also includes both modifications of the policies as well as new formulations.

Now Lets Have a Look on What all is covered in the annual report

Management’s Discussion and Analysis -

The name by it self explains that it contains the management’s statements about the financial numbers. The management hereby, describes the reasons behind the changes in numbers, be it the revenues or margins. A thorough study of this section shows the potential threats and the uncertainties the management expects to encounter in future.

Balance Sheet -

It is the summation of assets and liabilities at a particular point of time. The data from the balance sheet of the current year is compared with the data from previous year. The first section of the balance sheet includes fixed assets (good will, any land, building or plant) and the current assets (cash, short-term investment, prepaid expenses & taxes, outstanding bills, inventories etc). The second section comprises of the liabilities namely, loans payable, taxes payable, outstanding debts etc. This section also includes the value of all the stock owned by the shareholders. Some other heads included in this section are preference share, minority Interest and also the project in which the company is planning to re-invested or has already re-invested.

Statement of income and retained earnings -

The income statement together with balance sheet shows the company’s financial performance over a period of time, which is usually one year. This section gives a clear picture that how much money is left to reinvest in the company. Following parameters can be looked upon in the income statements:
· Sales Growth – One must watch the sales growth of the company. Analaysing YoY gives a good picture about the company like at which pace of the company is going. Some people also check the growth with that of other companies which the same area and of comparable.
· Earnings Growth – Earnings growth is a must watched out item in the annual report. One needs to look for whether the company has a record of beating the market estimation or not.
· Sales Costs - This is what costs the company to generate the sales shown in Total Sales Revenue. Comparing the total costs to the total revenue makes it necessary to also look at the cost of each line of product or service versus its revenue. Sales Costs is also known as Cost of Goods Sold (CGS). Analysing this gives a good picture like unlike cost components can swing up or their trends & how the company is dealing with such cost.
· Profit Margin – Is the company’s profit margin stable or increasing? This margin varies from industry to industry, but on the same hand is a good measure to compare similar companies, from either an investment or a benchmarking perspective. The basic idea is to check the company if it has good margin with that of other in the peer group. It is proved the company, which enjoys good margins, stand still comparatively in conditions like inflationary environment, competition etc.
· Company’s research & development expenditure either increases or decreases as percentage of sales. But one needs to analyse whether this increase or decrease is favourable for the company or not. Like in the case of Pharma, a decrease in research & development expense can turn out to be harmful for the growth of that company.
· Non-recurring Items - These numbers are shown separately in the income statement so that the investor doesn’t get confused with the “continuing operations” figures. This is one-time expense, or a non-reimbursed casualty loss.
· Statement of changes in financial position - This portion states the usage of working capital for daily operations. It also throws light on the working capital available over a period of time (which could mean several years), and also how it is put to use.

Auditor Report -

A very important part of the annual report is the auditor’s report in which the auditor claims that all the facts mentioned in the annual report are the true picture of the company’s finances. It also states that the report was prepared in the context to the auditing standards and the accounting principals.
What to look for
What generally means when we say what is the worth of a particular stock? This question, however, has different answers from different perspectives, but what everyone will commonly agree to is that a stock’s value is related to its future earnings. Research and analysis what we see, is designed to calculate the value of a stock. Every investor has his or her own perspective to look at the facts in annual reports; here are some more elements of an annual report, which are worth consideration.

Cash flow statement

In general increasing cash flows shows a positive sign for the health of a company. It is considered that a company with excess cash flow can raise dividends and survive recession periods without being forced to borrow money or sell assets. To arrive at the cash flow of a company, depreciation expenses and accounts payable are added back to the net income income. Then the capital expenditures, inventories and account receivables are subtracted from the above derived amount.

After analysing the financial statements above, we need to look out for certain ratios relating to the balance sheet, income statement and some efficiency ratios to get a clear picture of the company’s operations:

Balance Sheet Ratios:

Current Ratio – This ratio judges the company’s liquidity (also referred to as its current or working capital position) by deriving the proportion of current assets available to cover current liabilities.
Quick Ratio - This is a liquidity indicator that further refines the current ratio by measuring the amount of the most liquid current assets there are to cover current liabilities. It excludes inventory and other current assets, which are difficult to turn into cash. Therefore, a higher ratio means a more liquid current position.
Debt/Equity Ratio – The debt-equity ratio is a leverage ratio that compares a company’s total liabilities to its total shareholders’ equity. This is a measurement of how much the suppliers, lenders and creditors have committed to the company versus what the shareholders have committed. A lower the percentage means that a company is using less leverage and has a stronger equity position.

Income Statement Ratios:

Gross Margin - The gross profit margin is used to analyze how efficiently a company is using its raw materials, labor and manufacturing-related fixed assets to generate profits. A higher margin percentage is a favorable profit indicator.
Net Margin - Often referred as a company’s profit margin, the so-called bottom line is the most often mentioned when a company’s profitability is discussed. While undeniably an important number, investors can easily see from a complete profit margin analysis that there are several income and expense operating elements in an income statement that determine a net profit margin.

Other Efficiency Ratios:

Return on Assets - This ratio indicates how profitable a company is relative to its total assets. The Return On Assets (ROA) ratio illustrates how well management is employing the company’s total assets to make a profit.
Return on Capital Employed – The comparison of net income to the sum of a company’s debt and equity capital, gives investors a clear picture of how the use of leverage impacts a company’s profitability. Financial analysts consider the ROCE measurement to be a more comprehensive profitability indicator because it gauges management’s ability to generate earnings from a company’s total pool of capital.

Other Key factors

Also look for the investments made by the corporate insiders. An increase in the same is a positive sign. Also check whether the company is making sufficient earnings or revenues from its products in past few years. The annual report is the best source for this study.

Moreover, being an investor you should not hesitate to consult the company’s investor relations department in case there is any misconception regarding any explanation to any subject.

Conclusion:

This article has thrown light on some basic points to build up a decision regarding investment in a particular stock. Also one can research on the company’s competitors. May be after reading company’s competitors annual report one decides to buy the stock of a competitor company.