They're not exactly page turners,
but for investors they're often
a jackpot of information
By Rick Daysog
Star-Bulletin
The 65-year-old Foster Village resident admits that it takes a highly skeptical mind to delve through the financial data and make investment decisions based on the reports.
"You have to have a jaundiced eye when you read them," said Williams. "There's a lot of fluff."
Williams is a lot like many individual investors faced with the often complicated job of weeding out the fluff in a company's annual reports
Long on detail and short on explanations, the annual report is like the map to a corporation's treasure chest. It tells how much the company earned or how much it lost. It shows if income is rising or falling or if a company is saddled with debt. And it spells out the company's vision for the future and how it plans to implement that vision.
Sometimes, the annual report can reveal mismanagement.
While there's no absolute formula for reading an annual report, many experts recommend investors begin by reading the back of the report.
Key items from there include the income statement, the balance sheet and the footnotes to the statements. Here are some hints on what to look for in the reports:
The income statement. This tells the investor if the company is profitable or is losing money. It also spells out where a company's sales are coming from and how the company is spending its money.
The net income is what the company has at the end of the reporting period, minus all of its expenses and taxes.
Some believe that a more accurate picture of a company's day-to-day operations is found its operating income, which excludes one-time gains or losses from items such as land sales, plant closings or accounting adjustments.
When a company relies on such one-time gains frequently, it can distort its profitability picture. That's especially true if the company uses the gains frequently to live up to Wall Street analysts' earnings expectations, said David Houle, chief financial officer of Bancorp Hawaii Inc.
The point is underscored by Dresser Industries Inc.'s 1988 report. The Dallas-based oil and gas equipment supplier reported a net income of $156.8 million for the year-ending Oct. 31, 1988, or more than triple its $48.9 million profit in the year-earlier period. But much of the increase came in the form of a $22.7 million gain from discontinued operations and $11.3 million in tax credits - hardly reflective of the company's daily operations.
For many, a good gauge of management's effectiveness can be found in a company's return on investment ratio. That's derived by dividing the company's net income by the stockholder equity, which is listed in a company's balance sheet.
While the return on investments vary by industries, a general rule of thumb is that a 15 percent return on equity is healthy. Anything lower than prevailing rates on bank certificates of deposits would not be desirable.
The balance sheet. The balance sheet shows what a business owns - such as real estate, plants, equipment or inventory - as well as what it owes. It also shows how much cash a company has in its coffers.
A company that's loaded with cash is attractive since it's a good sign that the company can meet its obligations. It also could indicate a dividend increase or a stock buyback down the road.
Too much debt, on the other hand, would make it difficult for a company to meet its obligations, especially during a downturn.
One quick way to measure a company's financial health is to calculate its debt-to-equity ratio, according to Edd New, managing partner of Ernst & Young LLP's local office. You get this by dividing the company's long-term debt by its stockholders equity and multiply by 100.
Again, ratios vary by industries. But generally speaking, you don't want a company to have a higher debt-to-equity ratio than those held by its competitors. To find out the standard debt-to-equity ratio for a particular industry, consult your broker or the company.
A heavy debt load helped land HAL Inc., Hawaiian Airlines's former parent, in bankruptcy reorganization. The company, now known as Hawaiian Airlines Inc., filed for Chapter 11 bankruptcy in September 1993 with debts of $320 million. The airline has since emerged successfully from the reorganization.
The auditor's statement. Annual financial results are often audited by an outside accounting firm to ensure the company's finances follow normal accounting standards. The accountants, in turn, issue an opinion letter that's included in the annual report.
If the auditors qualify their opinion, it's a warning flag, said Marty Plotnick, president of Creative Resources Inc., which conducts due-diligence work for local businesses.
A qualified opinion could mean that the auditor only signed off on a portion of the company's financial data or that management and the accounting firm don't agree over items in the financial report.
In some cases, it could be a sign of more serious problems such as fraud.
On rare occasions, the accounting firm will resign. That's what happened in 1987, the accounting firm then known as Ernst & Whinney resigned as the auditor for a carpet cleaning business known as ZZZZ Best Co. ZZZZ Best later failed and its founder, Barry Minkow, was convicted of securities and mail fraud.
Pay attention to the chairman's letter. It's easy to dismiss this part of the annual report as management's attempt to put its spin on the company's past-year's performance. But many experts consider the letter an integral part of a report. Unlike the balance sheets and income statements which contain historic data, the chairman's letter lays out the company's strategies for the future and how it plans to implement them, said Steven Dawson, business professor at the University of Hawaii.
"If you get a straightforward statement at the begining of the report, then you have a company that's in touch with reality and is leveling with their shareholders," Dawson said.
Read the notes. Buried in fine print, the notes to the financial statements contain an avalanche of information about a public company.
Some of the data involves arcane detail on cost-cutting moves like the sale of company cars and corporate jets. But other times, they contain disclosures that can have huge consequences on a company's operations.