Well, a lot has been written about “How to read a company’s annual report”. Having read quite a number of annual reports, I would like to share a few pointers which might be of help to starters.
The importance of reading annual reports can be gauged from the statement in the image. And it is quite imperative that in order to make money in the market, you need to be reading lots of annual report.
If you are overwhelmed by the thoughts of reading annual reports, hope this article on “How to read a company’s annual report” will help you expedite the process.
First and foremost, reading through only one year of annual report won’t give you much insight. One needs to go through at least 5 years of annual report.
You can get the annual report on company’s website(Sharing the screenshot) or you can Google it as well as you can find it on Moneycontrol. I will take the example of N R Agarwal industries as I am going through the company currently.
To make more sense out of the annual report, you need to first go through the company’s numbers.
You can find the financials of publicly listed companies on multiple website, of which Edelweiss is the best.
Based on the whatever seems out of ordinary, prepare a list of questions. Once you have the list of questions, it helps focus on those key points and makes reading the annual reports much more efficient.
How to read a company’s annual report
Let’s see the financial statement of NR Agarwal industries & prepare our list of questions.
Before we find the answers to our questions, let me brief you on what all you need to go through in the Annual reports.
1. About the company
2.Director’s report: The MD talks about the last year’s performance and factors contributing to those numbers.
3.Management Discussion & Analysis: The most important part. The management talks about the industry, the company, future plans etc. One needs to analyze how much the company had planned in the past & how much have they achieved, getting a sense of management capability.
4. Q&A: Many AR consists of Q&A section with the management.(Not mandatory)
5. Financial Statements
Let get back to our initial questions & try to find the answers.
1. Reason for loss in FY14 & FY15?
Shown in the images above, the Directors’ report talks about external factors in addition to the increasing interest cost & depreciation.
To validate the external environment, one can quickly look at the financial performance of the top players for the same year. (Source: Edelweiss.in)
As you can see in the pictures below, the Profit margins shrunk for the major Paper companies be it JK Paper, & West coast paper & Intl APPM, thus validating the point made by the management of NR Agarwal industries.
2.Sales growth driver 2014-16
Sales grew from ₹525 cr in 2014 to ₹925cr in 2016 and that’s a significant jump.
Now the details about the capacity in the AR of 2015-16 was available in the MD&A whereas for 2014-15 was available in the About the company section.
So, here keyword search helps. Will share a list of keywords below which will help you to find relevant information.’
3.Debt reduction plan
Although the AR for both 2017 & 2018 talks about reducing debt, but in the Q&A section of Annual report of 2018, the MD of NR Agarwal industries talks about further expansion indirectly implying enhancement of debt.
4.Improving Operating margins?
The management team of the company gave nothing concrete on the improving operating profits. To analyse, one can check the margins of the industry in general, which we can see in the “Reason for loss in FY14 & FY15?” section.
One can observe that the margins have been improving for all the companies implying a tailwind for the industry in general.
Few more points
1. Start from the oldest Annual Report to the latest one and observe what all the company had envisioned to do and what all they have achieved.
2. Is the management talking too much about share price?
3.Be wary of management issuing warrants without any reason just to increase their stake.
4. Change in accounting methodology- Look primarily for change in depreciation & inventory accounting methodology
But not all annual reports are equally informative. Smaller companies in particular don’t spend much time preparing the annual report and many of them just copy paste the previous years comments/statements. But that should not be taken a something negative and one should try to get the information from external sources if possible.
Given below if the Management Discussion & Analysis report of a small company by the name of “Kanchi Karpooram”. There is significant improvement in the financials of the company but there is no information on the reason for such turnaround.
While reading the lengthy Annual report, its possible to miss out on certain items, so it makes a list of keywords to search in the AR.
Few keywords that can help:
Warrants, Capacity, Production, Borrowings, Debt, Director’s report, Directors’ report, Board’s report,Remuneration/Salary, Notes to/on the Financial Statements,Notes to the Standalone financial statement, Growth, Utilization/ Capacity utilization, Expansion, Challenges etc
I will keep adding more keywords & will cover on how to analyze the financial statements in the coming blogs.