How to Read Letters in Annual Reports

To help us put things into context, I want to share a story of a friend of mine, Bruce. Bruce is a brilliant entrepreneur and businessman. One of his cash producing business is a chain of retail shops selling mainly earrings. The story in summary is that Bruce left his job as an auditor at one of the Big 4 Audit firms and started his chain of shops, all starting from shops at Pasar Malam (night markets). He gets his supplies of earrings by flying to Bangkok with a huge suitcase. When he returns to Singapore, he would display them at his Pasar Malam stalls and sell them.

Now, let’s say Bruce is asking us to buy over half of his business and become part owner of his chain of Pasar Malam stalls, will we want to do it?

Remember that we have a list of questions established in the earlier posts? Now we need to know how to find these answers. The best place to start is to read through the annual report prepared by Bruce’s business.

 

Being able to read the annual report like an investor will open your doors to many opportunities a well as help you avoid many bad investments. So using Bruce’s business as the example, we will take a look at the information provided by the annual report and see if they can give us the answers that we want.

Part 1: Letters and Business Discussion

What you will find in part 1 of the annual reports will be chairman letter to shareholders, business overview, review and future outlook and plans, management discussions and Q&A, risk management and corporate governance.

While reading through this segment, seek to find answers for the following:

Item Questions Remarks
Understanding the Business How does the business make profit?

 

What is the product or service it is providing?

 

What is the key strength and uniqueness of the business that allows it to make profits and protect itself against competition?

 

How has the business been performing?

 

What are the key concerns (risks) of the business and are they being managed well?

 

What are the future plans of the business?

 

Are the future potential for growth?

 

In your opinion, is the business going to be able to continue to produce good profits?

 

Is technology going to affect business?

 

If after reading through, you are not able to understand how the business is making profit or if you are not able to make a good judgment on whether the business have long term prospect, this may not be within your circle of competence.

 

If business has many revenue components, assess based on key revenue drivers.

Understanding the Management Does the management have relevant background?

 

How long have management been in position and what kinds of results has business produce when they are in management?

 

 

If it is new management, do they have good track records from previous experiences?

 

We want strong and honest management team. While this is subjective, here are some guides:

 

  1. If management has stayed long with business, they are likely to have ownership and loyalty

 

  1. If management had previous cases of dishonesty or fraud cases, we better stand clear.

 

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Cheers,
Mind Kinesis Research Team

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