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The Annual Report Filtered And Decoded

The annual report of a company is one of the most useful sources of information available publicly for investors and stakeholders alike. An annual report is a document released every year by a company, which is a detailed and comprehensive record regarding various aspects of the company such as its general details, who they are, what they do and also throws light on the overall industry outlook, operations and financial performance of the company in a given year.

It is extremely important for both existing and potential long term investors in a company to read and understand the annual report to know how their company is doing, because it is the only piece of information about the company that comes straight from the horse’s mouth. But alas, this doesn’t happen most of the time. Why? Given that the average annual report runs from anywhere between 80-300 pages, is extremely textual and laden with complicated business jargon and is focused more on marketing information rather than conveying it, makes the annual report a very boring read. That’s where this piece comes in.

This piece, quite in line with ValuePickr’s motto, will show you how to separate the wheat from the chaff in an annual report and help you focus only on those things which merit attention. So, let’s get this show on the road.

When reading the annual report, it is important to remember something known as the 80-20 rule (80% of the quality information in the report is contained in 20% of the report’s quantity). I give here a list of the only sections in the annual report of a company which deserve attention and the insights that can be drawn from each section:

  • Initial Page: The initial page of an annual report gives a brief account of basic company details such as names of directors, executives, auditors and bankers of the company. It also gives an idea of whether or not it is a family run business (if most of the names in the directors and executives lists have the same surname it is pretty safe to assume that it is a family business, but do bear in mind that this may not always be the case).

  • Chairman’s Message: The chairman’s message or chairman’s letter is an open letter from the chairman to various stakeholders in the business. This is important because it shows what the chairman thinks about the business and where he expects the business to be in the future. The best chairman’s letters are those where the chairman is realistic in his projections and offers valuable insights into the business. Watch out for ones where the chairman makes too many forward looking statements which seem unrealistic.

  • Board’s Report: The board’s report is a report written by the board of directors of the company which throws light on aspects such as number of subsidiaries, board remuneration and related party transactions (transactions between holding and subsidiary companies). Companies with too many subsidiaries and/or related party transactions are best avoided

  • Shareholding Pattern: This section shows the shareholding pattern in both subsidiaries (whether it is a partly or wholly owned subsidiary) and the holding company (how much is held by the promoters and how much by other parties). Look for companies which are majorly held by promoters having wholly owned subsidiaries.

  • Corporate Governance Report: The corporate governance report throws light on aspects such as board structure and composition, remuneration paid to directors and disclosures of related party transactions. Look for companies who disclose related party transactions in as much detail as possible and remunerate their directors fairly and stay away from those which do the opposite.

  • Management Discussion And Analysis: This is the most important part of the annual report and deserves the most attention. Here, the management of the company gives an overview of the economy, the industry in which it operates, and the company being studied. They also give their expectations of the company’s direction in the forthcoming periods. A good way to gauge management quality would be to look at management expectations in previous annual reports and see whether they have been able to deliver on those expectations. You could also look at annual reports of other firms in the same industry and see how they are being managed, and compare with the company you are studying.

  • Financial Statements: This section throws light on the financial performance of the company in the period gone by. It contains important statements such as the Balance Sheet, Profit And Loss Account. It is always better to look at consolidated financial rather than standalone financial statements, since consolidated financial statements also incorporate the financial performance of subsidiaries

So this was a brief overview of the annual report, the important sections of the annual report and the insights that can be drawn from each section. I would also recommend a YouTube video titled ‘How To Read An Annual Report With Karthik Rangappa’ for more detailed insight on the subject. I admit this piece is a bit too long, but between reading a 80-300 page annual report and reading this piece, I think the latter is definitely the lesser of the two evils.

In closing this piece, I genuinely hope that all who read this piece find it useful and learn to incorporate the power of the information in the annual report into their investment decisions

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Thanks Akshay for the detailed post. I always find your posts informative and they add/multiply my knowledge, (like compound interest!) I learned a lot from your valuation piece as well.

I wanted to ask: Do notes to Financial statements also help? To determine where the money is being spent/earned and finer details. Also is the accounting aggressive v/s conservative?

@JayNach First off thank you so much for the kind words. I myself am less than a year old as an investor, so this coming from you means a lot to me. Coming to your queries, the notes to financial statements do help if you want to understand the numbers in greater detail. But as far as the aggressiveness or conservatism of the numbers is concerned, I really can’t say anything because there is always a degree of management bias built into the numbers, so it is usually as conservative or agressive as the management likes. Focus more on the on ground realities of the company rather than the numbers.

Hope you find this explanation helpful.