Annual Reports: What They Are and Why Investors Care
A Company's Annual Report to Stockholders Is Among Its Most Important Documents
Many investors know that they are supposed to request a company’s annual report to understand the business but they don’t really know what it is or why it is important. I want to take some time to explain it to you, as well as explain how you can get your hands on the annual report of a business in which you are interested in making an investment, whether that interest falls more toward becoming an owner by purchasing stock or lending money to the company by purchasing bonds.
What Is an Annual Report?
The annual report is a document prepared by a company’s management to the shareholders and stakeholders, including employees, unions, vendors, and regulators, explaining what happened in the business for the year. There are no real rules for what an annual report contains and some companies don’t even prepare one. Often, though, a lot of time and effort is put into this special document resulting in valuable information that you can't discover easily anywhere else.
Most annual reports begin with a shareholder letter from the Chief Executive Officer. While some businesses use this as little more than an opportunity to have a ghost-written marketing message pushed to a large audience, many CEOs work long and hard on their letter, using it as a chance to provide insight into the state of the sectors or industries in which the company operates, the nature of the competition faced by the firm, challenges or opportunities that have presented themselves, an explanation of some of the causes behind the figures found in the financial section, insight into the future of leadership at the business (especially in cases where the CEO plans on retiring), modifications in dividend payout policies, and much more.
Although you never want to make an investment based upon the "tone" of an annual report, it can give you important clues about the type of people to whom you are entrusting your precious capital. There are certain signs of shareholder-friendly management that tend to exert themselves in ways that let you know you're dealing with people who are interested in protecting your assets. As you gain experience, you'll also begin to recognize other signs that you're dealing with someone who shouldn't be trusted or isn't competent.
Off the top of my head, I can name a handful of management teams for firms in the S&P 500 that I don't trust. As a result, I either won't invest in the business or require a much larger margin of safety than I otherwise would were I dealing with someone that I believed both honest and capable.
How Is the Annual Report Different from the SEC Form 10-K Filing?
If the Form 10-K Filing is regular Coca-Cola, the annual report is Diet Coke. It is a softer, more accessible, easier-to-understand version of the company’s finances, business, and management philosophy. The Form 10-K is often hundreds of pages of text, financial statements including the income statement and balance sheet, and legal disclosures. The annual report, on the other hand, often has abbreviated data with lots of pictures, colorful graphs, and images of smiling employees. There are always exceptions, of course.
Each business is unique and the annual report can even vary from year-to-year. Some businesses really stand out for the quality of their annual reports; something you'll come to appreciate as you grow your brokerage account and portfolio.
Some companies don’t prepare an annual report at all, instead releasing everything in the Form 10-K. Other companies combine a short annual report with the Form 10-K. Still others have a very, very lengthy annual report and their 10-K statement consists of nothing but the saying, “incorporated by reference from the company’s annual report.”
The bottom line is that you need to read both the 10-K and annual report to get a full understanding of a company. It's astonishing that people will spend more time investing and comparing two brands of refrigerator than they will examining two different companies in the same industry, throwing their life savings into an enterprise based entirely upon emotion. It's a tragedy because the power of compounding means each dollar lost represents a lot of future wealth flushed down the proverbial toilet.
How Do I Order a Copy of a Firm's Annual Report?
Most companies post their annual report on their website as a free download, often in Adobe PDF, Microsoft Word, and/or HTML formats. If not, you can call or email the investor relations department and request printed copies be mailed to you, which most firms still do. These should always be free.
Learn More About Annual Reports
Take a few minutes to read What is a Form 10-K Filing and Why Should an Investor Read It?. It will tell you much more about what you're looking for than the annual report. You can also check out my Guide to Financial Statements.