The 7 critical items to read first in an annual report in 20 minutes (Part 2 of 9)

This is a series of articles describing how to quickly understand the key aspects of the annual report from a company that you have invested in with your hard earned money. This series started with an overview post on November 30, 2010.

1. Profitability

The most important thing to look at in annual report is the profitability of the company and its change from the previous year. If you have spent any amount of time on this site, you will know that you cannot confidently invest in a company that is not profitable.

We also want to understand the “why” of the changes in profitability. It is not enough to know that the company made more or less money, but why did it change. Was it due to more or better products or was it due to an accounting change or a currency change?

The financial data for the company should be in “Item 6. Selected Financial Data” of the report. The very first line is likely to be a revenue or sales line. Did it go up from last year? Did it go up enough (the goal is at least 10%)? If it didn’t go up enough than this likely to be a problem and you may want to just stop investing in this company. There are plenty of companies that are growing by 10% so you may not want to invest in a company that can’t figure out how to grow their top line fast enough.

Further down the table you will see a Net Income line (or perhaps it will be called Net Revenue). Once again, the big questions are:

  • Did it go up?
  • Did it go up enough from last year? The threshold is still 10% growth!

If the company was able to increase top line revenue adequately but not increase the net revenue, you should be concerned. Perhaps you should look at the costs that were taken from the top line revenue number and deduce what happened.

On the flip side, perhaps you shouldn’t worry about the reason things didn’t work out for this company. It is not your job as a small investor to understand why things are not working to your expectations at your company. You can simply choose to not be an owner of this company if it doesn’t live up to your expectations. Don’t spend your precious time trying to fix the company - that is what the managers that are employed there need to do. As an investor, you need to decide if they are performing the job well and then decide if they deserve your investment dollar.

Here are the links to all 9 posts of the series:

  1. The 7 critical items to read first in an annual report in 20 minutes (Part 1 of 9)
  2. The 7 critical items to read first in an annual report in 20 minutes (Part 2 of 9)
  3. The 7 critical items to read first in an annual report in 20 minutes (Part 3 of 9)
  4. The 7 critical items to read first in an annual report in 20 minutes (Part 4 of 9)
  5. The 7 critical items to read first in an annual report in 20 minutes (Part 5 of 9)
  6. The 7 critical items to read first in an annual report in 20 minutes (Part 6 of 9)
  7. The 7 critical items to read first in an annual report in 20 minutes (Part 7 of 9)
  8. The 7 critical items to read first in an annual report in 20 minutes (Part 8 of 9)
  9. The 7 critical items to read first in an annual report in 20 minutes (Part 9 of 9)

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