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Six Things in an Annual Report Necessary for Fundamental Analysis

Part of the Fundamental Analysis For Dummies Cheat Sheet

After a huge annual report arrives in the mail, you may not know where to begin. So here are six things you should always consider when you get an annual report to make sure you are picking up the key elements needed in fundamental analysis:

  • Compare this year’s annual report with last year’s annual report. The best way to read this year’s annual report is side-by-side with last year’s. Make sure the company achieved the goals it set for itself. If the company missed its goals, that’s a good place to start using your fundamental analysis skills to figure out why management fell short and whether it’s a reason to be concerned about the company’s future.

  • See how cash flow compares with net income. Accounting rules give companies a fair amount of leeway in how they report profits. Cash, however, is cash, and this line item is particularly important in fundamental analysis to assess when making investing decisions. You want to make sure that the company is bringing in roughly the same amount of cash as it reports as profit.

  • Consider operating and gross margins. Too many investors get overly consumed with a company’s bottom line. However, the amount of profit a company generates should be considered in comparison with its revenue. Operating and gross margins, two financial measures fundamental analysts pay close attention to, let you do this analysis.

  • Look for any deterioration. If you’re investing in a company because you think it has great growth prospects, make sure it’s actually growing. A basic analysis of a company’s fundamentals, including revenue and earnings, will show you how to do this pretty quickly.

  • *Take a look at the CEO’s paycheck. Most annual reports come packaged with a so-called proxy statement. These statements typically tell you how much the top executives are paid. Sometimes this information is found in the annual report. You want to be mindful that excessive compensation could be a sign that top management is out for itself, not you. Paying attention to executive pay is a way to look beyond financial statements to perform a complete analysis of a company.

  • Sleuth for potential conflicts of interest. The proxy statement also allows investors to vote on key matters. Don’t just rubber-stamp directors the company recommends for the board. Check the proxy to see if those people have any business dealings with the company. If so, you might withhold your vote for them. Voting for members of a company’s board of directors is a way to use fundamental analysis to safeguard your interest in the company.

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