Reading the Annual Report Can Help Company Investors

Tom Rosencrants finds it incredible that some people who invest their hard-earned money in a company take less than an hour to read the firm’s annual report.

But in most cases, the investment expert says, that’s just what happens.

“The typical small investor doesn’t know how to get the most value out of reading an annual report,” he said. “They don’t know the red flags or the important things to look for. They thumb through it and look at the pictures.”

Rosencrants, director of research for the Interstate-Johnson Lane investment firm, says annual reports can be intimidating. But most of the 12,000 or so publicly held companies in the United States try their best to present useful information in understandable terms, he said.

“There’s no difficult math in an annual report,” he said. “It’s all addition, subtraction, division and multiplication.”

Still, according to the National Assn. of Investors Corp., the country’s largest individual investor association, the average shareholder spends about 40 minutes looking at an annual report.

“That’s a little scary,” said Ken Jenke, president of the group, based in Royal Oak, Mich. “When you own a company, you should have a sense of what’s happening.”

Now that it’s the season when annual reports are arriving in the mail, Rosencrants offers some tips for the average shareholder or potential investor:

Carefully read the chairman’s or chief executive officer’s letter to shareholders.

“For well-managed companies, this letter will be straightforward and easy to understand,” he said. “The letter should also address setbacks that may have occurred and discuss ways the company plans to manage its way around these obstacles.”

Give special attention to the report’s narrative, which is where companies usually reveal their management strategy.

“A key here is to be able to read that management is taking aggressive steps to correct any business disappointments,” Rosencrants said. “Look for discussions of new markets and how they are being pursued, as well as an analysis of changes in market conditions and how the company will respond to those changes.”

* Be wary of any company whose annual report paints a too-rosy picture of past performances or future successes.

“A red flag should pop up if management spends too much time congratulating itself,” he said.

* Read the footnotes in the financial section. “Footnotes can contain potential bombshells,” Rosencrants said.

* Keep a file of past annual reports and read them.

“The first thing I do before I consider investing in a company is ask them to send me their annual reports for the past 10 years,” Rosencrants said.

“Last year’s goals become this year’s achievements. Last year’s predictions become this year’s realities. If not, the good companies will tell investors why and go on and say how they change their strategy to deal with their markets.”

* Finally, read the opinion of the independent accounting firm that audited the company.

“If the auditor ‘qualifies’ the opinion by mentioning a setback or pitfall that could affect the company, it’s time to take notice,” Rosencrants said. “Be wary if the company has not explained what it plans to do about the problem.”

In most cases, he said, companies put out annual reports that don’t mislead their investors.

“There are some exceptions to that, but for the most part, they do a pretty good job,” he said. “They tip off the caliber of the management.”

All it takes is common sense to understand the financial information and put it to the best use, he said. In some cases, that means getting out of that particular investment.

“People in my business who do this every day are always asking questions,” Rosencrants said. “When we don’t know the answer, we ask more questions.”