The annual report is the most useful tool that a stock investor has at their disposal. Leave the charts, trends, and outside analysis to someone else.
The annual report is the source of nearly all relevant information there is about a given company. And the best part is, it's free! You don't have to waste a dime to learn whether or not a company will be a good investment.
You can usually go to the investor relations link on a company's website to find the annual report. It is often labeled as the 10-K report.
Disclaimer: For those who are new to reading annual reports I must warn you, they can be incredibly boring. In time you will learn to recognize the parts that are just fluff and skip only to the important parts, but if you're just starting out I recommend that you press through and really dig into the first few reports to get the hang of it.
So how will the annual report help you grow your investment wealth? Here are 3 ways:
1. You will familiarize yourself with the various business risks that the company and the industry face.
Some of the risks are general risks that all businesses face. Others are risks that are specific to the industry. And some may be unique to the particular company that you are considering.
When you know what the risks are you wont be tempted to sell your stock just because the stock market is down. Why bail out? You understand what makes your business succeed or fail.
Only a fool enters a business without doing his best to understand the potential pitfalls. Stock ownership is no different. So learn the particular risks that your company faces.
2. You will gain an understanding of how your business makes money.
This is not always as straightforward as you might think. The biggest companies have many divisions functioning differently which are often earning money in completely different industries or markets.
You do not need to understand every minute detail of the process, but you ought to be able to explain exactly what business you are in. You should generally have it mapped out in your mind or even have it scratched out in a notebook. Be able to sound intelligent when talking about your company's value proposition or why their customers should do business with them.
Most importantly you need to have a strong resolve that this business will be a profit producing business for the next 5-10 years. You should even feel encouraged by the companies 15-30 year outlook.
3. You will learn what kind of financial condition the company is in.
This part of reading annual reports has the steepest learning curve. It involves looking at the company's financial statements. The balance sheet, the profit and loss statement (P&L), and the cash flow statement are the main ones.
Analyzing these statements with clarity does take some practice and probably some outside study of what the statements are used for. There is some good study material out there if you do a google search for "understanding financial statements".
Enterprising investors must put in the time to learn the skill of using financial statements.
Only passive investors, who are content with average results, are allowed a pass on this task. And passive investors should not be buying individual stocks in the first place.
For the enterprising investor these statements are the beginning point in understanding if a company is a good business or not. From there, the statements will lead the enterprising investor to determining if the company's shares are currently selling at a discount or at a premium.
One final tip
Choose about 3 companies that you are interested in. Go to their websites and download their most recent annual reports. Investigate the 3 things we learned here.
1. What are the risks?
2. How does the company make money?
3. What financial condition is the company currently in?
When you understand these factors you will be well ahead of most stock market speculators who call themselves investors. And you be better poised to make intelligent investment decisions that will result in a lifetime of financial wealth.