Who says annual reports are boring? Take this year's compendium from the H. J. Heinz Company (you know, the ketchup maker). It's oozing with page after glossy page of crimson tomato art. The company that makes 500 tomato-tempered products commissioned a handful of artists to produce a 44-page tribute to the fruit responsible for 30 percent of its sales.
But if you're like most investors, once you flip through all those pretty pictures and scan a few pages of print, you're done. The last section, stuffed with accountant's lingo and six-digit numbers, is seldom glanced at.
Maybe it is worth a glance. Even if you have a broker or especially if you do your own investing, a perusal of the financial statements (with calculator in hand) can yield a wealth of information. You'll find out how your money was spent and what it is earning, and see where management is heading next year.
But before you leap into the company's figures, make three stops:
* President's or management's message. This epistle to shareholders tends toward puffery, but it does give an overview of the year's accomplishments and will make passing references to the trouble spots.
* Discussion of operations. This is a facts-and-figures analysis of the year's business. You'll find a little more about which divisions or products were successful and which areas are sluggish. Look for trends in the numbers given. If domestic sales are up, how much more did the company spend on advertising this year to produce that increase? Again, be wary of hyperbole.
* Accountant's report or auditor's statement. Here, an independent accounting firm tells which statements it has reviewed. It does not vouch for every figure or every page of the annual report, only those stated. In the last paragraph, the auditor gives its opinion as to whether management has prepared its books in accordance with generally accepted accounting principles. Pay close attention to this paragraph. If the auditor finds anything misleading, it will say so here and describe the discrepancies in the preceding paragraph.
OK, bring on the financial statements.
The balance sheet
This a snapshot of everything the company owns - and owes - as of a given date. There are two basic parts to a balance sheet: assets (what the company owns) and liabilities, including stockholders' equity (what the company owes). The two parts are always equal, or in balance.
Typically, assets include cash, marketable securities, accounts receivable (less allowances), inventories, land, buildings, equipment, and prepaid expenses.
Liabilities usually include accounts payable, notes and bonds payable (short- and long-term debt or loans), income taxes, dividends payable to stockholders. Plus stockholders' equity, which falls on the liability side of the balance sheet and includes common stock, capital in excess of par, retained earnings, and treasury stock. (See definitions.)
Before you try to decipher what this means, every accountant and stock analyst contacted points out that a single annual report is of limited value. When you look at a company's numbers, you're looking for trends. Since most annual reports provide you with only two or three years' worth of complete data, it helps to have a preceding year's annual report. And it's important to have annual reports from several companies similar to yours to compare performance.
Now, flick on that calculator.
One of the basic tools used in assessing a company's relative health is the current, or working-capital, ratio.This gives an idea of a company's ability to raise cash and pay off near-term debts. If creditors want their money, can the company raise it? To get the current ratio, divide current assets by current liabilities.
As a rule of thumb, a ratio of 2:1 or higher is considered sound. This means there are $2 of assets for every $1 of current liabilities. ''It's hard to generalize about ratios, though,'' says Gerald Gold, supervisory analyst at Prudential-Bache, a New York brokerage house. ''For example, a regulated utility doesn't require the same degree of current assets as consumer-oriented businesses, such as beverages.''
Another handy tool for annual report readers is the debt-to-equity ratio. This potent little indicator looks at how a company is using debt (other people's money) to generate earnings (and, you would hope, boost the value of your stock) or perhaps is going too far into debt, which can use up cash (and reduce your dividends and slow growth) by having to pay interest on the debt.
To get the debt-to-equity ratio, divide total liabilities by total stockholders' equity (except preferred stock). Most businesses keep this ratio below 1:1.
The income statement
Sometimes called the profit-and-loss statement. It is essentially a moving picture of a company's performance during a given period. Here income from sales of products and services is matched against the costs of running the business. When you subtract the expenses from sales, you get the net earnings (or net loss). Some of the expenses you're likely to see are cost of goods sold, depreciation, selling and administrative expenses, interest, and income taxes. (See definitions.)
One indicator of management's performance is the pretax profit margin. To compute this, divide pretax income by total sales. Compare this number with previous years. If the profit margin is increasing, it may mean the business is becoming more efficient. If it is dropping, management may be having problems or competition may be heating up.
A company could have robust sales year after year, but a check of the profit margin can be revealing. ''At first, the home-computer-game business had high (profit) margins,'' says H. Barry Burris, director of accounting and Securities and Exchange Commission technical services at Coopers & Lybrand. Sales volume continued to increase, but as competition grew, profit margins got thinner. ''They were running like crazy just to stay even,'' Mr. Burris recalls.
Most people who invest in stock hope to earn more than if they put their money in, say, a money market fund. To make such a calculation, the return on equity (ROE) ratio is handy.
To figure ROE for common stock, subtract the preferred stock dividend (last year) from the net income (this year). Then subtract the value of this year's preferred stock from last year's stockholders' equity (both numbers are on the balance sheet). Now, divide the first answer by the second answer. If the result is, say, 14.6, you know that for every dollar of stockholders' equity you made 14.6 cents. A money market fund now earns about 10 cents to the dollar annually.
There are several more statements in an annual report that lay bare a firm's operations. For instance, the statement of changes in financial position (also called sources and uses) spells out how a company generates and spends its cash.
And footnotes are not just interesting tidbits in an annual report. ''They're integral. You cannot read a financial statement without looking at them,'' advises Steven E. Anderson, the partner in charge of auditing at Peat, Marwick, Mitchell & Co.'s Boston office. Footnotes, for instance, will reveal pending litigation that could hurt future earnings. A company, however, rarely admits that a lawsuit will succeed against it. Read between the lines of a rosy outlook or check newspaper coverage on the case.
How do you get a copy of an annual report? Any company listed on the New York Stock Exchange must send copies to its shareholders each year. Most companies will mail one upon request, even if you're not a stockholder.
For more detailed, yet simple step-by-step analysis of annual reports, the following publications are available.
''How to Read a Financial Report.'' Free pamphlet. Merrill Lynch, Pierce, Fenner & Smith, Sales Promotion Dept., 12th Floor, 25 Broadway, New York, N.Y. 10004.
''Reading and Evaluating Financial Reports.'' Six- to 10-hour self-study course. $49.95 for two books. Xerox Learning Systems, PO Box 944, Hicksville, N.Y. 11802.
''Understand Those Financial Reports: a Question-and-Answer Guide for Investors,'' by Raymond J. Lipay. $19.95, plus local sales tax. By mail: Order Department, John Wiley & Sons, Eastern Distribution Center, One Wiley Drive, Somerset, N.J. 08873. Consolidated Statement of Earnings In Thousands of Dollars except per share amounts) Years ended April 30 1984 1983 1982 Revenues:
Product sales $145,946 $ 98,366 $100,731 Service 27,647m 18,881m 14,025m 173,593m 117,247m 114,756m Cost and Expenses:
Cost of sales and service 87,418 60,711 63,719 Selling, general and administrative expenses 49,629 37,400 36,222 Research and development 10,594 8,771 8,628 Interest expense 3,506 4,520 4,190 Other income (2,080) (1,035) (2,614) Gain on subsidiary's issuance of common stock (483)m -m -m 148,584m 110,367m 110,145m Earnings before income taxes and minority interests 25,009 6,880 4,611 Provision for income taxes 10,600m 2,875m 1,700m Earnings before minority interests 14,409 4,005 2,911 Minority interests in subsidiaries' operations 268m 512m 462m Net Earnings $ 14,677m $ 4,517m $ 3,373m Net Earnings Per Common Share $ 1.42m $ .48m $ .36m