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A Cheat Sheet for Annual Reports

Reading a company's annual report isn't like breezing through the latest best-seller. But the information in a Form 10-K, the annual report that public U.S. companies must file with the Securities and Exchange Commission, can steer you toward winning stocks and away from losing ones, notes Nellie S. Huang, Kiplinger’s Personal Finance.

To find a firm's latest 10-K, check the investor relations section of the company's website or search the SEC's Edgar database (www.sec.gov/edgar.shtml).

The trick is not to read the entire tome, just the parts that matter most, says Huang. She suggests looking for the following sections:

Business

A report starts with an overview of the company. It will tell you what the company does, how it makes money, who its competitors are and where it stands in its industry. It can be a window into company culture. Alphabet's overview begins, "Google is not a conventional company. We do not intend to become one."

Risk Factors

The company must describe any issue that could adversely affect the business. Some are obvious, such as a recession. Look for unusual ones, such as a single product or customer accounting for a lopsided share of sales. In its 2018 10-K, Spirit Aerosystems Holdings said 56% of revenues came from selling components to Boeing. Since Boeing halted 737 Max production, Spirit stock is off more than 30%.

Selected Financial Data

This table of key performance data in each of the past five years shows the firm's sales and earnings trends over time. If the company's financials have increased steadily, and the management team is still in place, it's a sign that the firm may deliver similar results in the years ahead.

Management's Discussion and Analysis This will highlight business results over the past year compared with the previous one. The writing can be dry. Tables, if the section has any, can be informative. Gilead's MD&A, for instance, includes a table of revenue in 2018 and 2019 for each of its drugs. Turns out sales are shrinking for one of its top-selling drugs.

Financial Statements

The auditor's report is a declaration from an accounting firm that the 10-K "fairly" presents the company's current financial position. "Critical Audit Matters" can point to potential problems. Boeing's 10-K notes that the estimate of liabilities related to the 737 Max's grounding require a high degree of "auditor's judgment" to assess. In other words, the estimate is far from certain.

The income statement is a report of sales, expenses and profits in each of the past three years. Look for a rising trend. Big swings in revenue or net income, however, may require digging deeper. Focus, too, on net earnings rather than earnings per share, in part because share buybacks, which cut the number of outstanding shares, can skew earnings per share.

The balance sheet is a snapshot of the company's financial health. It shows the firm's assets and liabilities. Have retained profits – the earnings a company pours back into its business – risen steadily? Look for little or no long-term debt on the balance sheet. Good companies generate enough profit per year to cover their long-term debt obligation within three to five years.

Editor’s Note: Nellie S. Huang is senior associate editor at Kiplinger's Personal Finance magazine, www.Kiplinger.com.

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