I have previously discussed the qualities Warren Buffett (Trades, Portfolio) looks for in a management team before he decides whether or not to invest in a business.
As the Oracle of Omaha explained, he is looking for evidence that management has achieved the goals it set out to, and if it hasn't, explained why.
How management communicates with shareholders is another qualitative factor Buffett likes to use to assess the managers he's investing with. An essential document for doing this is a company's annual report. Specifically, he wants to see whether or not an annual report is telling him enough about the business to make an informed decision about whether or not to buy the stock.
Annual report information
Buffett highlighted the qualities he was looking for in an annual report at the 1998 Berkshire Hathaway (BKR.A) (BRK.B, Financial) annual meeting of shareholders.
Answering a shareholder who asked him for "advice to understand annual reports," Buffett explained that the first place he starts is "the reports of companies that we think we can understand."
He then went on to explain:
"And then we see from that report whether the management is telling us about the things that we would want to know about if we owned a hundred percent of the company. And when we find a management that does tell us about those things, and that is candid in the same way that a manager of a subsidiary would be candid with us, and talks in language that we can understand, it definitely improves our feeling about investing in such a business. And the reverse turns us off, to some extent. So if we read a bunch of public relations gobbledygook, you know, and we see lots of pictures and no facts, it has some effect on our attitude toward a business. We want to understand the business better when we get through with the annual report than when we picked it up. And that is not difficult for a management to do if they want to do it."
What makes a company tick
In other words, what Buffett appears to be looking for is a detailed description of the company and what makes it tick, explained in a way that anyone can understand.
Accoridng to Buffett, the annual report should contain enough information for any investor to understand the business without having to communicate with management. Because managers are not available to most shareholders, the quality of the information displayed in the report should not lead to an unequal playing field compared to the small number of shareholders with access to management's explanations.
Buffett explained that he made the decision to buy shares in Coca-Cola based not on discussions with management, but by reading the company's annual report and the information contained within it.
A good report can be a reason to buy a company, and a bad one can be a reason to sell. After explaining what he was looking for in an annual report at the 1998 meeting, Buffett handed the microphone over to his right hand man, Charlie Munger (Trades, Portfolio), who went on to add the following:
"If you've got a standardized bunch of popular jargon that looks like it came out of the same consulting firm, I do think it's a big turnoff. That's not to say that some of the consulting mantras aren't right. But I think there's a lot — that for a sort of candid, simple, coherent prose — a lot to be said for it."
Those are Buffett's thoughts on reading annual reports. Like so much of his advice, the ideas are not particularly complicated, but implementing them could be if you do not have the time and patience to read annual reports.
Disclosure: The author owns shares of Berkshire Hathaway.
Read more here:
- Some Insight Into How Buffett Has Used Float to Leverage His Returns
- Warren Buffett's Thoughts on Finding Good Managers
- Warren Buffett: It Is Not Always Worth Chasing After Growth
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