Quarterly financial statements and annual company reports are the language of investors and executives. At the end of the day, the results of managerial business and capital allocation decisions get translated through audited financial statements, which, like haikus and box scores, require interpretation and translation. While investors and analysts claim to like transparency, the reality is the reading and interpreting of financial statements requires practice and patience (and interest).
Warren Buffett, for example, has interest. He reads 500 pages per day. He says that, while others may enjoy Playboy, he prefers annual reports and financial statements. (No comment).
Annual reports can yield valuable information, even if you are short on time. Reviewing annual reports can better prepare you for working with customers, suppliers, and your markets. They can yield insights, benchmarking and market intelligence. If you had 20 minutes, where should you focus? I think “L-L-C” to prioritize three things with the goal of understanding how a business makes money, how the managers/leaders think (and who they are), and the overall performance of the firm.
- Letter: read the Chairman/CEO letter. While some write this off as “fluff”, it always included business highlights (and lowlights, reasons, and excuses; make sure to know the difference). The letter will include noteworthy investments and efforts, and usually discusses the strategy and the business model.
- Leadership: understand who runs the company, including the Board of Directors. Look at the makeup, backgrounds, and skills of those who control the company. This can be especially relevant in smaller firms, and recent changes to the Board can highlight firm priorities.
- Cash: confirm how cash is generated and used, including financing. Are the core operations generating cash? How is the company using that cash? How are they financing investments into growing the firm? The ability to review the Statement of Cash Flows can benefit from a brief tutorial, but it is straightforward once your eye knows where to go. At the end of the day, numbers need to match.
If you have more time, read the Business Description to confirm the business model, business segments, key customers and exposures.