How to Read an Annual Report – 10k for Beginners

by birtanpublished on September 13, 2020

Hi i'm jimmy in this video we're going to run through how to analyze an annual report now i'm hoping to keep this process fairly simple so even if we're beginners to investing or beginners to analyzing companies

We should be able to use this process to help us better understand a potential investment the goal of this video is for us to better understand what's important to look at when we're

Reading an annual report and what's a good order to go about tackling a brand new company if we're looking to analyze the company for the first time how do we what's the process to go about

That and hopefully we can use this information to try to better understand companies and hopefully use that information to pick better investments and ideally get us

Closer to our goal of achieving financial freedom okay now i'm also very proud to announce that this is actually my second sponsored video we get a lot of offers for sponsored videos now that we're over

100 000 subscribers the channel gets a decent amount of offers but some of them i really just don't like this sponsor for this video is actually the same

Video sponsor we had from the last time called borsa earnings calls and basically it's a way to listen to companies earnings calls sort of like you would listen to a podcast it's free it's an easy app to

Use but we'll touch more on that in a moment so for now let's jump into how to read an annual report now i'm going to use apple as a tentative example as sort of the template for what we're doing

But you can apply it to any company this is what apple's table of contents looks like for the annual report also known as a 10k now the very first section i like to go to

Is the business section the business section is a great way to get a better understanding of the company's background and how the company looks at their own business because they usually

In fairly plain language describe what their business is all about so the company can also break out what the company sells they might maybe they segment them by perhaps product type or product category they

Could also break them up by region maybe they break it out by country or continent or something along those lines but they usually give you a good understanding of what the company does

And how how to segment and the good part is this section generally isn't all that long apple as an example they're pay their business sections just four pages and they break out their revenue

According to the products that they sell so it's a nice clean way of doing it and then after we're done with this one section well now we get to make a decision so is this a company that we're interested in

Investing in we get to ask that question if it's not perhaps a reading about it and it doesn't seem like a business that has a great future well we can just not read any further we could simply eliminate the company which

Is a great option to have since we don't have to swing at every investment opportunity that we come across we read about as many companies as possible until you

Only find the handful of companies a few dozen companies whatever it ends up being that you really love but you get that by going through many different companies okay now the next section we're going to

Want to read in our annual report is management discussion and analysis sometimes you might hear this called md a for short and basically what this does is this is the management's opportunity

To get more numbers behind what they do the business section really describes what the business is trying to do and the md a section is trying to explain how they're actually doing what's their performance

Actually been like what's their plan things along those lines maybe they even talk about some of their competitors so if you've seen some of our videos on this channel where we analyze a different company well oftentimes it's

This section of the annual report that allow us to create the charts where we're breaking out the business by segments or talking about the revenue within different uh

Business lines of different regions this is where a lot of that information comes from now this is also where i like to listen to the earnings call now i find that earnings calls and the management discussion and analysis

Section often go over a lot of the same information so this is a natural segue into the borsa earnings call app by the way if you're curious i've got a

Link for the app in the description below for both android and apple devices so if you want to go download just click over there like i said it's free but one of the things i like about this

App is that you can create watch lists you can see future earnings calls you can listen to any investor presentation pretty much that they're putting out on the internet

This app gets a lot of them so i think it's a really great app and it's free to use and it's easy it's like i said it's very simple sort of like listening to a podcast and one of the advantages to listening

To the call versus just reading the management discussion and analysis is that you get to hear their tone you get to hear the company's tone you get to hear

Questions that analysts ask that the company maybe wasn't ready for so you get to hear their reactions to all of that so i think that this listening to an earnings call

Coupled with reading the management discussion and analysis can be a great combo as to truly understanding the business okay now moving back to frankly it's now or another decision point

In our analysis do we continue to like the company if we do we move on to the next step if not once again eliminated we're always looking for reasons to eliminate companies because

If you eliminate all the bad ones in theory you're left with only the good ones so assuming we like the company well we now move over to looking at some of the numbers

Now this part of the investment analysis is a bit tricky and and it can't be a bit more skilled based generally the more we understand about how companies are supposed to report earnings

The more effective we can analyze financial statements but there are some tricks that we can use that even beginning investors who know very little about accounting can there's a process you can go about

Uh to make it understanding the business simpler so first let's pull down the income statement this is apple's income statement for the end of 2019. so personally what i like

To do is i like to convert some of these numbers over to percentages they call this common size analysis here's what i mean so we start with their revenue and apple

Was kind enough to break their revenue into the products that they're selling so they have products and they have services so if we were to divide the products revenue by total revenue

Well then we end up with about 82 for 2019. so now we know that product sales accounted for about 82 percent of revenue in 2019. now is that a good thing or a

Bad thing well we don't really know right now it's just a reference point so what if we did the same thing for 2018 and 2017 well now we can see that product sales

Have actually declined on a percentage of total revenue from year to year now that's not necessarily a good thing or a bad thing management might very well have a good plan as to why that's happening

But it is an interesting thing to note and it's really only you can only really tell that by doing this type of analysis now what if we apply the same thing to apple's gross profit margins

Well gross profit margins are about 38 percent when compared to total revenue for the year and we can see when we look at the other years that's been fairly consistent once again we can repeat this process

For net income once again in apple's case we see good consistency at least over these past three years now if we wanted to go a bit more in depth

Well it could make sense to go back and look at some older annual reports and create these very same charts that you might see in some of the videos that we've done on this channel where we analyze the company

This is how you can do that we can look at what is the total percentage and what is the actual trend okay now we're going to shift over the balance sheet and i'm actually going to break the

Balance sheet into different sections just because the balance sheet is really long it's tough to fit on the screen so the first section of the balance sheet of the balance sheet is assets and what we're looking at here

Is we're looking for total assets that's right down here and then once again we can convert any one of these numbers as a percentage of total assets now we could then compare these results to

Calculations from previous years or perhaps we we would feel more comfortable with comparing it to a competitor we could do the same thing for everything we looked at in the income statement

The point is by coming up with percentages well it doesn't really matter how large the company is that's why they call it common size analysis because by bringing it into percentage well now

We can see it's much cleaner to see how this company is doing against another company or how segments do from year to year so i think it makes sense to do both look at both how the company does

Compare to itself and find a close competitor and try to compare it to that okay simple enough now we're actually going to lock in this total assets number down here at the bottom and then we're going to switch this to

The to the liabilities section of the balance sheet now once again the same math applies we can take any one of these line items that we decide we can compare it to total assets and just like that we

Might be able to look at how much they owe versus how many assets they have now i also want to point out that we can mix and match how we compare numbers in this case i'm using total assets and

That's a very good place to start but you might also hear people compare let's say current liabilities to current assets well they call this the current ratio it's a very good number to use so you

Can mix and match how you're comparing it as long as you want to do the same thing throughout time if you're comparing it to time and or competitors if you're doing that compared to the same

The same data points you can also compare it to total revenue or for perhaps profit so there's lots of ways to slice this i personally income statement i like to could start with total revenue

Balance sheet let's start with total assets and then break things down from there so then we would do the same thing for the equity portion of the balance sheet i would compare that to total assets

Okay now we shift over to the cash flow statement now for the cash flow statement i like to start with total revenue as the comparison number break down the percentages

And if you ever download all this stuff to excel well it becomes really easy to compare numbers into you know drag and drop formulas so for cash flow statement i generally like to start with total revenue when i'm coming

Up with some comparison points so in apple's case we take the total net sales and then we compare that to let's say the operations portion of the cash flow statement

So now we can run the cash flow numbers against total sales now personally common size analysis is a fantastic thing to do but sometimes on the cash flow statement i also like to look at

The numbers sort of the hard numbers to see how they actually look to see if that tells us anything interesting for example cash flow from operations well this is one of the key numbers

This is how much cash the business generated from ordinary operations and generally we want this number moving higher through time and then when we switch over to the investing and finance sections

These are on the cash flow statement as well they're below the cash flow from operations section well now we can see some interesting things we can note that apple has been buying back shares on a fairly regular basis

We can also see that they've paid out some dividends those dividends have increased each year then we can also see that they've issued some shares that's why this number has gone up

Although this number is fairly low relative to the rest of their numbers so i'm guessing because this number is so low this is probably somehow tied to stock options that were exercised by employees or management or board the

Board of directors whoever it was but if we're not sure and if we want to dive deeper into any one section of the anal any one section of the financial statements well oftentimes in the footnotes of the

Financial statements the footnotes will explain what happened or what accounting methodology they're using so even if we're brand new to investing reading the footnotes about a section

That perhaps looks unusually large or something along those lines reading the footnotes can be a smart thing to do because sometimes they'll explain it for us and if nothing else it'll certainly make

It easier to google what a particular line item is supposed to do now at this point in time we should have a good idea a good understanding of what the business does what their potential is and whether or

Not we think that they're a fundamentally sound business so again we get to make another decision because after this there are only a few other statements that could be interesting to look at

We've already looked through the annual report so there's only a few other things the earnings calls are a good place to start we'd want to try to come up with a fair value of

Whatever we think that that company is because once we know okay we like the company the next question is where do we buy it we'd like to probably look at some of their press releases perhaps some news

Now i actually did a video another video similar to this one where i go beyond just the 10k or the annual report and i go through the process the entire research process

So if you're curious perhaps that could be a good next video for you to watch i got a link right here i've got a link in the description below and don't forget go download the free bursa earnings call app i got links in

The description below and thank you so much for sticking with me all the way to the end of the video i really appreciate it thanks and i'll see you in the next video

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