Most investors never review company annual reports. It’s easy to understand why. Full of facts, figures and detailed accounting notes, these reports are hard going. They’re not exactly bedtime reading.
However, annual reports often contain valuable information for investors. As such, they shouldn’t be overlooked, no matter how dry the material is.
So, what’s the best way to read these reports? Is there anything we should be on the lookout for that might provide insight into a company’s financial position that we might have otherwise overlooked?
At Berkshire Hathaway’s 1996 annual shareholder meeting, one investor asked Warren Buffett that very question.
Buffett declared there was one thing he’d like annual reports to detail more than anything else. Specifically, he said:
“The main thing that they can’t mandate in annual reports: I really like to have — I like to know as much as I can about the person that’s running it and how they think about the business and what’s really going on in the business. In other words, I would like to have a report that would be identical to what — if I owned half of a company but was away for a year, and I had a partner who owned the other half — when I came back, that he would tell me about what had taken place during the past year and what he foresaw coming up and all of that.”
As Buffett noted in his response in 1996, this qualitative factor would be impossible to force companies to comply with.
Nevertheless, he went on to provide some advice that could help investors answer the above question:
“What I’m trying to do as I read reports, I like to understand just generally what’s going on in all kinds of businesses. If we own stock in a company and in an industry, and there are eight other companies that are in the same industry, I want to own or be on the mailing list for the reports for the other eight, because I can’t understand how my company is doing unless I understand what the other eight are doing. I want to have the perspective of, in terms of market share, what’s going on in the business or their margins or the trend of margins, all kinds of things that I can’t get unless I know — I can’t be an intelligent owner of a business unless I know what all the other businesses in that industry are doing. And so, I try to get that information out of a report.”
By gaining an understanding of the company and its competitors, Buffett has been able to build a mental model of the company’s strengths, weaknesses, opportunities and threats. It will have also provided a picture of management.
While this approach is time-consuming, Buffett went on to add that it has provided more ideas than traditional research reports.
“I don’t think we’ve ever gotten an idea, you know, in 40 years from a Wall Street report. But we’ve gotten a lot of ideas from annual reports.”
The goal of this process is to understand the business and its competitors, thinking like a business owner, rather than a stockholder.
“There’s no short cut,” as Buffett concluded his response in 1996, “You’ve got to understand the businesses. That’s where it all begins and ends.”