Plumbing the depths of the corporate annual report

Lots of pretty pictures. Many annual reports do have some of the best photography anywhere. The slick pages are often filled with picturesque scenes of places around the world, happy families enjoying the newest products of industry, and imaginative photographs that make pieces of machinery look like works of art.

But after you get through the prety pictures, how do you use the annual report to learn if the company you're interested in is a good investment? Or, if you already own stock in the firm, how is it doing?

The first thing many people read is the letter from the president or chairman of the board, says Jane V. King, who is regional vice-president for Keystone Massachusetts Inc. and is reporsible for the 12 mutual funds managed by Keystone. The president's letter is where the average person can find most of the information he or she needs on the company, she says.

Supposedly, Miss King says, This letter tells both the good and bad things that happened to the company in the past year.But in trying to find the less-than-glowing information, she continues, an investor will get a lot of practice "reading between the lines."

An analytical investor will look for areas that appear to be "glossed over," she says, and try to find out more about these items.

Here, as with other parts of the annual report, she says, it is a good idea to "find a broker you feel comfortable with the discuss these nebulous points.

Also, if it is possible, it would be a good idea to obtain the company's annual reports for the previous three or four years and see how the president's letters compared. Were predictions made that failed to come true? (Presidents usually do not make specific projections. Through generalizations, however, they often give a hint of where they expect the firm to be in the near future.) If the precidency has changed hands, how has this affected earnings?

The next major section is often a description of the firm's various operating divisions. Depending on how diverse the company is, this section can be a few paragraphs or several pages long. one thing to look for here are areas which could help the company's earnings in the future: Perhaps a new product has been introduced, an acquisition has been made that expands the company's line, or a small division that has been quiet for a while is ripe for a takeoff because of an increased demand for its products or services.

The next section, which contains the "meat" of the annual report, consists of the financial statements.m There are many elements to this section (too many to be discussed in full here) and they may appear complicated. But they can be helpful to the person who knows what to look for. Comparison with reports from companies in similar businesses in useful.

The 5- and 10-year summaries give a comparative record of the firm's expenses , earnings, and losses for the current and preceding years.The also give related per-share earnings or loss figures. These summaries can tell an investor if the company's earnings are decreasing or growing erratically. If sales and earnings are up and profits margins are down, it could mean poor cost control or it could mean costs of production and distribution are growing faster than the company can raise prices to pay for them.

Whether or not the annual report carries lovely photographs, the next section si considered by many to be a "snapshot" of the company at a particular point in time -- the close of the last business day for the reporting year.

This is the balance sheetm of assets and liabilities, or, what the firm owes and what it owns. Assets include cash, accounts receivable (money owed the company for goods and services sold), inventories, and the equity held by shareholders.

Miss King recommends investors look at current assetsm -- those that can be quickly turned into cash -- and compare them with current liabilitiesm -- those due within one year. The difference between the current assets and current liabilities is known as the net working capital.m Many investors like their companies to have a comfortable amount of working capital to help it meet obligations, expand, and take advantage of opportunities.

Nonfinancial companies, Miss King says, should have on hand twice as much in assets as they do in liabilities. This figure, which some call the current ratio,m may be smaller than 2-to-1 if a company has a small inventory and if the money others owe it is easily collectable. A higher ratio would be desirable for companies which have a higher proportion of their current assets in inventory and which sell their products on credit.

Here again, Miss King says, comparison is in order. An investor should check the current ration with that of other companies in the same field.

For many investors, the "payoff" comes in the income statement,m sometimes known as earnings report, or the statement of profit and loss. This answers the question: How much money did the company make last year?

Most companies list their income figures in two columns that campare the current year with the previous one. The statement shows the income received from selling the goods or services and matches it with all the costs required to opecate teh company. It ends up with the famous bottom line" -- a net profit or loss for the year.

Among the tidbits an investor can find here is the percentage of profit growth. By dividing the operating profit into the sales figure for each of the two years shown, you can see if a firm actually has a higher percentage of profits, rather than just increased profits. A greater percentage means the companyis actually becoming more profitable, and not just growing.

Many other investors are interested in a figure known as the price-earnings ratiom , or the relationship between the company's price on the stock market and its earnings per share.This can be found by dividing the earnings figure into the market price. So if each share is selling for $25 and earning $1.50, the P-E ratio would be 16 to 1 and the stock is said to be selling for 16 times earnings. This figure is useful when comparing the company over several years of operation and with similar firms.

An item often found on the same page with the income statement is the accumulated retained earnings statement.m While investors like to see income and profits grow, company executives like to see this figure getting larger, because it shows how much money they have to plow back into the business for more growth.

Often the last page of figures is the statement of source and application of funds,m sometimes called consolidated statement of changes in financial position.m This page adds net income and depreciaiton to give total cash flow and shows what the company did with the cash. These uses amy include paying stock dividends, investments in plant and equipment, tax payments, or buying shares of the firms's own stock.

After reading and analyzing all this, it is important to remember, Miss King points out, that a truly educated investment decision cannot be made on the basis of the annual report alone. People who are interested in sinking cash into the business should also consult their brokers, ask for any research reports that may have been written by stock analysts recently, read articles that might be available on the company, and generally "ask around." The annual report, she says, "is just a beginning."