Sunday, July 22, 2007

Research Series Part 4 – The Annual Report

Part 4 of the research series focuses on the review and analysis of the Annual Report. This is a report sent by the company to all shareholders once a year to update shareholders on the business operations, provide financial figures and to offer guidance for the business in the coming financial year. As far as I know, most people treat the Annual Report as either a paperweight, or something to stack up with their old newspapers in order to sell to the karang guni. In other words, no one pays much attention to or attributes much significance to the Annual Report.

This behaviour is prevalent but it is a gross mistake on the part of the shareholder. Annual Reports can yield a ton of valuable insights about how a company operates, what it owns, what is has acquired/disposed of, revenue recognition principles and a host of other financial and operational information. This is a very good way of understanding more about how a company works and to also learn more about the profiles of the people running the company (i.e. the Board of Directors and Management Team).

In this post, I shall highlight the important aspects of the Annual Report to look out for (this applies to almost all Annual Reports) in order to gain a better awareness of the company and its underlying business:-

  • Business Activities and Group Structure – This portion tells you about the company’s principal activities and how many countries they operate in, as well as giving information on the different business units and segments the company has.
  • Chairman or CEO’s Statement – This part of the Annual Report is very important; as it sets the tone of the whole report and gives readers an insight to the attitudes, plans and vision of the head honcho of the company. It usually consists of a review of the previous financial year, key events, how those key events have affected the company, as well as future plans and strategies for the next financial year. Some CEOs may even give their own detailed analysis and views on the industry prospects and whether conditions will be “challenging” or not. What’s important is to pick out the tone and candour within the statement and see if the CEO is being candid or evasive about his company’s performance. While there is no hard and fast rule for this, reading many annual reports will enable the shrewd investor to eventually pick up nuances within the statement which may hint on potentially good or bad news to come.
  • Operations Review – This essentially sums up the year under review and gives the shareholder a bird’s eye view of what has been going on, as well as what plans are being undertaken to expand the business. Some companies go to great lengths to write about their achievements and customer wins, while others only provide a snippet. Look out for practical reporting without over-the-top self-praise; management must be rooted in the reality and not stay in the clouds all the time. Using too much history to justify future performance is also not a good sign.
  • Significant Accounting Policies and Estimates – This section details the various accounting treatments for various items within the Income Statement and Balance Sheet, and is a good way of seeing how revenues are recognized, how certain assets are amortized or depreciated; as well as items which may be unique to the Balance Sheet like deferred expenditure for example.
  • Profit Before Income Tax – This note in the Notes To The Accounts will disclose important figures like the breakdown for depreciation or amortization, exceptional gains and losses as well as items like exchange gains/losses. It helps you to see how much of the profit is derived from recurring business and how much is a one-off effect.
  • Revenue – A surprisingly useful note, it actually gives the breakdown of the revenues generated by business unit, or by segment (the segmental report gives this too). Thus, one can see whether there is revenue growth within specific business units, as well as new revenue generated from any new ancillary segments that the company has.
  • Contingent Liabilities – This is an important note which informs the reader of any pending liabilities which have yet to be crystallized (recognized) in the books. These usually consist of lawsuits or warranty claims which are pending resolution.
  • Capital Commitments – Any company will have commitments for capital expenditure, and this note basically tells the reader how much the company needs to commit (some are contractual, some are not) in future financial periods. From this, one can project the amount of cash outflows to occur in the next few financial periods.
  • Events After Balance Sheet Date – Essentially, this is the latest “updates” provided by the company on what has happened since the end of the previous financial year, and the date of printing of the Annual Report. This is noteworthy as it provides a rundown of the company’s initiatives and strategies under-taken, possibly to grow the business further.
  • 20 Largest Shareholders – A summary is given (as at balance sheet date) of the twenty largest shareholders of the company. The reader can note if the company’s shares are tightly held by a few individuals; and what the free float is like in the market.

I will be illustrating with an example of an actual Annual Report soon (Pacific Andes and Boustead, I will choose one), to highlight the various points which shareholders should take note of. In the meantime, please take some time to browse through the entire annual report (from cover to cover) even though it may seem like a bedtime story !

My personal experience is that I have discovered much information and insights by reading through the Annual Report; and most of the time I formulate some questions and take some notes in order to clarify with the Management during the AGM. The next part of the research series will focus on the 3 key aspects of the financial statements (one part for each statement); namely the Income Statement, Balance Sheet and Cash Flow Statement.


Paul said...


Thanks for an excellent write-up on annual report.

Annual reports are useful not just for existing shareholder but also prospective shareholders as well. I usually read the annual reports when I researching a company as a first stop.

I regard the CEO/Chairman to be the most important section of the annual report for the reasons you mentioned.

I also noticed that companies that are not doing well, the CEO/Chairman tends to be very skimpy on details. And you may not even see pictures of the board of directors. :D

I will look forward to your later articles. Good work!

Fishing said...

Musicwhiz, I hope you will choose Pac Andes's annual report as I have the report and would like to see your train of thoughts. Of course, for selfish reason too.. that I'm vested.


musicwhiz said...

Hi Paul,

Thanks for dropping by and thanks too for your compliment. I agree fully that Annual Reports are a great way for prospective investors who wish to invest in a company. I myself studied the Annual Reports of Pan-U Marine and Amtek way before they were acquired (this would constitute mistakes of omission which I will detail in a future posting).

Haha, yes indeed for companies which are not doing well, the CEO tends to gloss over a lot of stuff and try to concentrate only on the positive. Well, the Annual Report is also a marketing effort by companies to "sell" themselves to potential investors. Some do it better than others. For Pacific Andes, I have also not seen their BOD's photos for 2 straight years (FY 2006 and FY 2007). Haha I do hope they got nothing to hide ! That's why I will be attending the AGM, to see what the chairman looks like ! :P

musicwhiz said...

Hi fishing,

Caught anything today ? Haha kidding ! Yeah, I will probably choose PAH because I have been making notes on the Annual Report as I go through it and I do have something preliminary compiled on it already. But it's still rather tentative at this stage. If anything is going to come out, it will definitely be before the AGM so that shareholders can sift through the issues and comment on them.

I may also be doing Boustead as well since I have the time. Heck, I was thinking, why not do both since I am going to read them both cover to cover anyway ? Haha.

Nah, it's not a selfish reason. After all, your nick is "fishing", so you need to "sell fish", hehe thus you are justified in being "selfish". (Lame joke, I can hear groans !)....

fishman said...

Hi musicwhiz,

Thanks for sharing your insight on this very important topic!

Am looking forward to your next posts on the financial statements!

musicwhiz said...

Hi fishman,

Ok, no problem thanks ! I don't usually blog continuously about a series, it's usually interspersed by other content. :)