The annual report contains many details of how the company is functioning, some of it key and some not so important. In determining what’s important and what’s generally not, I read books by Peter Lynch, Warren Buffett, Benjamin Graham--and others--with the question in mind: “What do you look at when analyzing the annual report?.” That resulted in the suggestions below, and the spreadsheet analysis tool. As you are probably aware, Warren Buffett considers an annual report recreational reading. I consider it a cure for insomnia. Therefore, we’ll hit the key points they mentioned as important then analyze the data.
The annual report is a multifaceted tool. To the company it’s largely a sales tool. To the investor it’s a source of information about the company—and somewhat difficult to swallow as a whole. The effort here is to bite off a bit here and there to get a feel for management and how the company is doing, then using the computer to help with looking at the numbers.
Annual reports have two major sections: the glossy paper at the beginning and the cheap paper everywhere else. To their credit, companies are beginning to include a copy of the 10-K and only a few pages of the “sales pitch”—the “financial highlights” and glossy pictures. The truly revealing information is on the mundane paper in the back and in the flimsy booklet for the annual meeting notice and proxy statement.
Buried somewhere in the Annual Report-- sometimes for good reason -- is a graph comparing the company's stock price history with that of a peer group and of the S&P 500 index. This graph can't be beat for a snapshot of a company's performance. If you look at nothing else, that’s worth the effort to find it. If you’re reading an electronic copy, search for “S&P” to find it.
Stay away from companies with numerous pages of explanatory notes except for industries such as banking, which require many notes. The general advice from Peter Lynch is to count the pages of notes, and if too many, stay away. As noted though, the number of notes is industry dependant. If the number of notes pages concerns you, compare to a peer company.
Search the report for key words such as litigation, relationships, acquisitions and joint ventures. If you find any of these topics, scrutinize them closely. Again, use the search function to find them in electronic reports.
The relationships area of the annual report discusses loans made to company officers as well as business deals in which officers in both companies are somehow related. If a search for acquisitions turns up a series of deals, be wary. It's often difficult to grow a company through acquisitions. Improving existing products and creating new, innovative offerings -- in other words, "organic growth" -- is usually a better way to grow a company and is more predictable.
The Letter to Shareholders or Letter From Management
Poor management relies on alibis and excuses when talking about lackluster performance, while good management discusses problems candidly and outlines a plan to reverse negative trends. They can’t lie, but can certainly cloud the truth if there is something to hide.
· Management's Discussion and Analysis (MD&A)
MD&A covers operating trends and market factors that affect growth, profitability and debt, key concerns of the Stock Selection Guide. If management indicates a downward trend for the future, review the assumptions in your SSG analysis. Here too, they can cloud the truth and make bad look good—or attempt to do so. What’s your gut feeling after reading these reports? Good or bad?...[Message truncated] | 
