Welcome to the first part in the intermediate guide to investing! In this guide, we will be focusing on a deeper level of analysis. If you've had your eyes on your favorite company, but are unsure about their growth prospects or financial stability, this guide is for you.

If you came from our beginner's guide to investing, where we introduce things like why you should invest, how to start investing, risks, rewards and strategies, welcome! Otherwise, do give it a read first!

Why Invest? - Beginner’s Guide To Investing (Part 1) | Investing For Two
Welcome to the first part in Investing For Two’s beginner’s guide to investing! It’s always an exciting journey to learn something new, and investing is something you definitely want to pick up earlier rather than later in your life. This guide will walk you through the basics of investing, all the…

In this intermediate guide, you will learn to:

  • Understand the importance of annual reports and quarterly financial reports
  • Understand balance sheets, income statements and statement of cash flows
  • Know key metrics about a company's financial health
  • Identify common pitfalls and warning signs
  • Learn about various investment products
  • Learn about risk tolerance and planning your financial goals
  • Learn about portfolio allocation to meet your financial goals
  • ... And more!

Chapters in this guide:
Part 1 - Why Read Financial Statements?
Part 2 - How To Read Financial Statements
Part 3 - 10 Key Financial Ratios & Metrics
Part 4 - How To Analyze A Stock
Part 5 - Portfolio Management & Asset Allocation
Part 6 - Portfolio Rebalancing & Market Conditions
Resource - Stock Analysis Checklist

In this first part, we will focus on the importance of annual reports, quarterly earning reports and financial statements. Why would you want to search and read them? What key information do these have? Let's begin!

What are annual reports?

An annual report is a report prepared by a company that is released to shareholders, usually at the end of each financial year. A financial year can vary depending on the company, as each company can determine what date they want their own financial year to end on to take advantage of tax rebates or other perks depending on their type of businesses.

In essence, a financial year is simply 12 months long with an arbitrary start and end date decided by a company whereby their finances are calculated by.

Within an annual report, the company will detail their plans for the near future as well as release their financial statements for the year, where financial statements simply mean a collection of data representing the financial state of the company, such as revenues, debt and so on.

The annual report mainly serves to boost investors confidence, as well as give a road map of the company's strengths and weaknesses to entice investors into continuing to support the company's future prospects. It also gives investors a glimpse into the financial state of the company.

Investors generally trust that the reported finances on the released report are correct, as providing erroneous or modified financial information is chargeable under fraud. The finances reported are further vetted by an external auditing firm, so they should in most cases be accurate and trustworthy.

While each annual report is certainly different, a typical layout might include:

  • Shareholder letter
    Here, the CEO of the company will give a quick address to shareholders in a letter, summarizing the key points in the annual report. This is generally meant for investors who simply want a quick overview and do not want to dig deep into the annual report, but still want a general report on how and what the company is doing.
  • Financial summary
    A short summary of key company finances that investors look out for, like revenue, earnings per share, dividends and so on (we'll go through these in the guide).
  • Business and future outlook
    An introduction to the company's main money making businesses and their worth in the economy.
  • Discussion and analysis
    Key pickings from financial data, followed by analysis provided by the company to explain events or anomalies to investors.
  • Financial statements
    The comprehensive annual financial data of the company for the financial year, including balance sheet, income statements and statement of cash flows.
  • Financial notes
    These include other ancillary data that would be useful to investors, such as the accounting policies used, some things not represented in the financial statements, earnings per share data and other things like company subsidiaries, investments, assets and other data.

    Accounting policies are the various ways of calculating finances that companies follow. Most companies generally follow the accounting standard of Generally Accepted Accounting Principles (GAAP) when preparing their financial statements. Different accounting policies may result in different numbers being shown.
  • Audit notes
    Here, we have the controls and procedures taken by the external auditing company to ensure that the financial statements reported are correct. These can include analysis on how the accounting department of the company calculated the numbers such as debt or taxes.
  • Board of directors and investor relations
    Finally, we have a list of the directors in the company's board and their roles. There's also the contact information of the company should investors wish to find out more information, and there may also be details about the company's upcoming annual general meetings, where the directors will address shareholders directly.

Whew. That was really long, wasn't it? Annual reports are indeed a slog to get through, and that's why the shareholder letter is at the very top - to summarize the entire thing and let investors who invest in many companies know the details at a glance.

Why read annual reports and financial statements?

While you can usually get away with just reading the shareholder summary, there are various things that can be left out of the shareholder letter - whether intentionally or unintentionally.

Sometimes, if a company isn't doing well, they tend to only put the good stuff up in the summary, and conceal the bad stuff in the financial notes, where most investors don't end up reading.

Therefore, for companies that you are looking to invest in for a long haul, or are putting significant wealth into, you might want to read the entire thing carefully, as long-winded and boring as it might be!

If you detect any anomalies in the summary or condensed finance data, you should delve into the financial notes of the company's earning releases in order to find out why. Sometimes, a company may appear to have high debt - but it turns out it was good debt that the company is leveraging on to get even higher returns. Sometimes, it's actually bad. You won't know until you read the report thoroughly.

For most intents and purposes, the shareholder's letter would normally be enough to give you a hint as to the company's situation. You can also find condensed versions of key financial metrics online to determine if a company is safe to invest in.

Condensed finances of Microsoft (courtesy of Yahoo Finance)
Condensed finances of Microsoft (courtesy of Yahoo Finance)

After all, if you're looking at a few companies, looking through too many of these reports would waste too much of your time. If you're engaging in dollar cost averaging and are a long term investor, looking at certain key metrics is usually enough to judge a company's financial health.

If the financial health is strange, or if you're uncertain about a company's prospect, that's when you can delve deeper into a company's assets, plans and other things to gain knowledge of the larger picture.

What are quarterly earning reports?

Companies also release quarterly earning reports, which also depends on when the company reports their financial quarter to be. However, most public companies standardize their quarterly earning reports to be during the "earnings season", which is generally 2 weeks after December, March, June, and September.

Unlike the annual report, which summaries the financial year of a company, quarterly earning reports provides a snapshot of a company's financial health during the financial year.

This can be useful for investors to figure out how the company is doing every quarter (every 3 months). It can also provide insights into whether a company is following their financial plan outlined in the annual report of the last year and their success in doing so.

Summary of key financial data (Microsoft 2020 Q2 report)
Summary of key financial data (Microsoft 2020 Q2 report)

A quarterly earning report is similar to the annual report, with less information. They generally contain:

  • Summary of key financial data
    This includes key financial metrics like earnings per share, revenues, net income and more, as well as comparisons between this financial quarter and last year's financial quarter. This helps investors to make comparisons to see if a company is improving or regressing year over year.
  • Forward looking statements
    Analysis from the company about the market and competitive landscape as well as financial impacts from these factors.
  • Income statements, balance sheet and statement of cash flows
    Financial statements for the financial quarter (3 months) as well as the comparisons between this financial quarter and last year's financial quarter for comparison.

As we can see, the quarterly earning report of a company is clearly a more condensed version of the annual report, and mainly serves to provide a comparison for investors.

Importance of quarterly earning reports

Based off these quarterly reports, analysts from financial institutions usually make predictions for the next quarter's financial earnings, predicting things like earnings per share, net income and so on.

Therefore, as it gets closer to the earnings call (when companies release their quarterly earnings report), you can expect to see more volatility in share prices as investors tend to make judgments about whether a company can hit analysts' expected targets, or fall short.

If targets fall short, you can expect the share price of the company to drop, and vice versa, although this may not always be true.

Microsoft 2020 Q3 earnings report summary
Microsoft 2020 Q3 earnings report summary

This is a small snapshot of Microsoft 2020's Q3 earnings report. The main gist of their report was that they were not overly affected by COVID-19, as shown by their increased earnings in all of their business sectors.

They also beat out analyst targets of $35.7 billion in revenue with a revenue of $36.9 billion, surpassing expectations even in these difficult times. As such, Microsoft shares soared after the earnings report release.

This is an example of how the earnings call can cause investors to change their valuation of a company's stock, and it is important for you to take note of these earning reports in order to keep track of the financial health of the companies you invest in.

Importance of financial statements

By now, we have a general idea of the reports that companies tend to release throughout the year for the information of investors. Within these reports, there's always the mention of financial statements.

The three main accounting sheets in the detailed financial statements provide a detailed look at a company's operations and are as follows:

  • Balance sheet
  • Income statement
  • Statement of cash flows

While most of the time we won't spend the time looking through all these in detail, it helps to know the basic gist of these financial metrics in case we need them to make more informed decisions.

These three financial statements are useful in giving us a comprehensive overview of a company's financial position. They also help you in seeing a company's growth over time as they are shown side by side with the previous year's financial statements.

They also highlight any financial difficulties a company is facing, allowing you to make the necessary adjustments to your portfolio ahead of time. They can reveal signs of a company experiencing financial trouble, allowing you to make more rational decisions.

In this way, we can get a clearer glimpse of how a company is performing, making them important to go through.

Summary

Most investors actually do not go through all these reports. As mentioned, it is extremely time consuming to do so. Personally, we feel that going through the key financial data is enough, and can give you a snapshot of the company's health without too much hassle.

This info-dump may be a bit boring to go through especially at the start of this guide, but we wanted to get it out of the way early on.

Remember, although reading the annual reports, income sheets and quarterly earnings report may be boring, it is necessary if you're investing large amounts, investing for a short term gain, or if you wish to gain a deeper understanding of a company.

Therefore, while we will not focus on the specifics of these reports, we do encourage you to read them for the companies that you invest in if you can. It is always good to have your own valuation of the company you invest in before putting your hard earned money in it wholeheartedly.

If you have understood the importance of financial reports, then do read part 2 of our intermediate guide to investing where we will delve into the three financial statements introduced above - the income statement, balance sheet, and statement of cash flows.

How To Read Financial Statements - Intermediate Guide To Investing (Part 2) | InvestingForTwo
Welcome to the second part in the intermediate guide to investing! In the first part, we learnt about the importance of annual and quarterly earning reports. In those reports, there are financial statements that detail the company’s financial state. In this part, we will teach you all about them! I…

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