The very first rule to any kind of successful investing is: research. Which can seem daunting to begin with but gets easier with some time and practice.
Your first and the best source is the Annual report. It is just a like a company’s report card. Published by the company in compliance with a set of rules and regulations it is meant to help the investor. To equip them with all the information on the company like: financial statements, progress made during the year, strategy to be adopted etc.
It’s imperative to always look at consolidated numbers reported on the annual report as they account for all the businesses a single company may have.
1.What kind of progress did the company make in the past year? Their future strategy? Management Discussion and Analysis?
This section the company analyses itself and the gives a detailed report on its performance. Generally, it talks about the industry's performance and compares it with the company. Along with the past it also mentions the future strategies to be adopted and plans for expansion. It helps the investor understand how the company is placed and assess its future.
2.What is the business mix? How much does a single product account for – concentration risk?
It is mandatory for every company to report the revenue it generates from every segment it operates in. It helps the investor decipher how diversified the company is. For instance, if you look at the Annual Report of Hindustan Unilever it has listed out revenues and operating profits from all its segments: Home care, Personal care, Refreshments and Foods. So, if sometime in the future the Food segment doesn't do well we needn't worry cause its only accounts for ~4% of revenues and some ~1.5% of operating profit.
3.Has the company been growing profitably? Has the profitability gotten better?
This comprises of sales, expenses and profits. You want to look for a rising trend in the sales of the company. Some companies also provide 5 -10-year snapshot of their financials which can be helpful.
Focus on the gross earnings. See how they have changed. Derive a quick ratio ((Total Sales-Total Operating)/Total Sales= Gross Profit Margin). Ideally, it should be on an upward moving trend. A gradually falling gross profit margin can a major cause for concern.
4.Does the company have enough to repay its obligations and grow? Is the company levered up with debt?
Cash and cash equivalents and Debt Profile on the Balance Sheet
High level of cash is not necessarily a positive indicator. Excess cash generated can be used for: paying dividends or for business expansion. If the company is already paying enough dividends and still has a pile of cash it could mean that the company doesn't have any more avenues to invest and grow. Banking stocks should not be judged from their cash holdings. They will have a large pile of cash as they park their customers deposits under cash and cash equivalents.
Factor in both long term and short-term debt. Compare it with the previous year. If it has reduced it's usually a sign of prosperity. And if the total cash has grown faster than the total debt then it's an improving balance sheet.
See how much % of debt out of total debt is long-term. In tough times it always helpful for companies to have long term debt because payment isn't due anytime soon. Young companies with substantial debt are always at risk.
Another way to judge the leverage is to compare debt to the equity of the company. A benchmark ratio should be 75% equity and 25% debt.
5.Does the company view Dividends the best way to reward its investors?
If you are buying a company for its dividend policies alone find one that has been paying dividends for 15-20 years. Else you're stuck with an average performing company and no dividends.
Check if the company will manage dividends in bad times. Cyclical businesses aren't good dividend payers. Not all good companies pay dividends. Warren buffet's Berkshire Hathway doesn't pay any dividends. They believe in deploying their cash back in their business and generate better returns for the investors.
6.Will the Board of Directors and auditors act in the best interest of the investor?
Board of Directors and Auditors Report.
Read up on the people presiding over the Board - see how many are independent members. Much of the board (more then 50%) should not be related to the management or the owners of the company.
Most corporates have now separated ownership and control. People who own the company don't necessarily run it. Look at the senior management: CEO, COO, CFO. Are they credible? Do they have a strong vision?
An independent certified accountant conducts an audit to verify that the company is following the prevalent accounting standards and the information is all-inclusive. An auditor's statement offering no explanation or any adverse opinion indicates that the company represented its numbers in a fair and just manner.
Financial statements are usually looked on by investors as data dumps that are difficult to navigate. However, analyzing an annual report in some detail from a variety of perspectives, can help the investor make an informed judgment on the company's investment potential.