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Reviewing a Company’s Annual Report

Whether you’re researching a stock to purchase or monitoring a stock you own, the company’s annual report should be central to your analysis. Annual reports contain a wealth of financial information, which can provide significant insight into a company’s operations. Keep these points in mind when reviewing the annual report:

  • Read the independent registered public accounting firm’s report. In most cases, you’ll find an unqualified opinion stating the financial statements were audited in accordance with standards of the Public Company Accounting Oversight Board and present fairly in all material respects the financial position of the company for the last three years. It should also indicate that in all material respects, the company has maintained effective internal control over financial reporting. You’ll want further details if the report indicates problems, concerns about the company’s ability to stay in business, or incidences where the financial statements do not follow generally accepted accounting principles.
  • Review management’s discussion carefully. You want to feel comfortable that management is candid and straightforward about the company’s results and is not glossing over problems or concerns. You should get a feel for the company’s future prospects, its competitive position, and any significant risks.
  • Look for important facts in the footnotes. Information about outstanding litigation, class action suits, derivative exposure, environmental problems, and unfunded pension liabilities can be found here, alerting you to potential problems. Changes in accounting policies will also be discussed. You can also find important information about the company’s business.
  • Analyze financial trends over at least a three-year period. Review whether sales and profits are increasing or decreasing. Also, calculate the profit margin and the return on equity, comparing these to prior years and to ratios for other companies in the same industry.
  • Review the company’s financial solvency. Calculate the current ratio (total current assets divided by total current liabilities) to track the company’s ability to pay creditors over the short term. Longer-term solvency can be measured by dividing total liabilities (the total of current liabilities, long-term debt, other liabilities, and deferred income taxes) by total assets. Compare these numbers to the company’s figures from prior years and to other companies in the same industry to see if there is cause for concern.

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Copyright © Integrated Concepts 2012. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.

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