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Why you should read Annual Reports ?

            Do you call yourself an investor when you’ve never read an annual report? Annual reports are sent to shareholders at the end of every financial year and published on the company website.It summarizes the performance of the sector and the company.It is a ready reckoner  of products, market share, and financial situation of a company.Charlie Munger says," You must value the business in order to value the stock".Annual reports help us to obtain clarity and insight about the business and it's competitors.

          Each annual report can be dismantled into four pieces- the director’s report, the auditor’s report, financial results and account notes. The director’s report describes the current economy and the sector, spreading light on the firm’s activities, challenges faced, opportunities to be tapped and future plans. Checking the information for flaws and comparing with other firms in the sector is the job of the investor. Here, reading between the lines is the rule.The law requires the company to publish the auditor’s report. The company’s statements are critically examined, with the stockholders’ interests in mind. Chances are that a few of the director’s statements are despised, although not directly, in the auditor’s report. Such discrepancies and accounting methods can be noted from this part of the report.

         The financial statement at the end of the report has three parts- the balance sheet, the income statement and the cash flow statement. The assets, liabilities and net worth of the firm are listed in the balance sheet. A company is called a fairly good business when it’s net worth has increased consistently over the years.Seeing a track record of double digit growth rate in company's networth is a positive sign. The balance sheet gives a clear idea about the capital, reserves, loans, permanent assets, current assets, long term and short term borrowings, etc. Income statement is about the net revenues, net profit and total expenses. Consistent rise in net revenues and profit attract the attention of investors.Money transactions, both in and out of the firm’s books, are listed under the cash flow statement. The ‘Cash Flow from Operations’ gives the amount of money earned from the sale of goods and services. Money from selling or buying of assets are listed under ‘Cash Flow from Investing’, and that from sale of shares or bonds, under ‘Cash Flow from Financing’. A company with a positive net cash flow over the years proves as a worthy investment. Otherwise, the consistency of returns are doubted. 

      An intelligent investor should not ignore a report section called ‘Management Discussion and Analysis’ . This is where the sector and the company are looked at together, considering all the qualitative factors,business model and future growth potential. “When others read the Playboy magazine, I read annual reports”, is a famous quote by  the greatest investor of all times, Warren Buffett. This mindset differentiates market participants blindly betting, and intelligent investors.