I believe that many people, especially beginners, put off reading an annual report because they find it troublesome. I wouldn't blame them, after all, I started out like that. When I had to read annual reports, I nearly died imagining looking through over 200 pages of words. Fortunately, you do not need to read too much of the details. As with the 80/20 rule, 80% of the report contains irrelevant information. Only 20% of the report contains the details that you need to know. For instance, the 20% for me consists of mainly looking through the director's report as well as the financials. I usually ignore the rest.
This is how I look at the report.
Director's report
First, I look at the director's report, which usually gives a brief overview of how the company is doing in general, and you can see what businesses the company is in. These are usually right at the very front of the annual report so that you don't miss it. Some companies such as Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial), Markel (MKL, Financial), and The Hour Glass make it easier for common people like us to understand what in the world they do.
These companies also treat the readers of the annual report like they are partners of the business. For the beginner starting out reading annual reports, these companies make it “user” friendly. I would say that their annual reports are like Apple (AAPL, Financial) products, easy to understand and use. Hence the tone that they use is much clearer and easier for the lay man to understand.
You can start by reading those reports first as they are easier to digest. These director reports are usually very comprehensive, much like the summary page of a book. They will give a brief overview of how the company has done for the past year, and what to look forward to in the upcoming year. Depending on who writes it, it can be 10 to 20 pages long.
On the other hand, most of the annual reports that I read usually talk about the specific business. REIT’s will talk about the specifics of the rent industry. Waste management will talk about the specifics of that industry and so on and so forth. You would need industry knowledge beforehand in order to understand the jargon that they are talking about.
Financials
The next thing that I look at is the company's financial statements. The company's financial statements indicate how the company's business is doing. I always like to look at the five-year difference in terms of revenues, assets and earnings. It is good to be able to see an upward trend in terms of these indicators. It means that the company is doing well and is well-managed. This means that shareholder value is also increasing because these companies are adding values to people's lives. McDonald's (MCD, Financial) sells burgers to its customers, Old Chang Kee sells Curry Puffs to its fans, etc.
If the company has a variation of earnings, meaning that the earnings fluctuate a lot, it could mean that the company's earnings are very cyclical. For instance, the majority of construction and oil companies have very cyclical earnings. For certain periods, they tend to do extremely well with very high earnings. In other years, they can do terrible. I have come across companies that sometimes have a PE ratio of 1 just because their earnings that year are not too good (I will talk about this in another post).
Usually, companies do not put the full five-year breakdown. They will just show the current year's results as compared to the previous year.
The other 80%
The other 80% of the report may not be relevant. Some people may want to see how management is being compensated, how many meetings they attend, etc. There are also those who want to see who owns the company. Is the majority held by management, or are they held by mutual funds? At the end of the day, how much you want to zoom in on the report is entirely up to you. With beginners, I would recommend just the director's report and financials so that you don't get a headache.
