Wednesday March 10, 2010

How to analyse company statements and reports

Personal Investing - By Ooi Kok Hwa

Analysts usually judge the quality of a company’s management team by looking at the comprehensiveness and truthfulness shown in the management statements

FOR the next few weeks, investors will start to receive annual reports for companies that have their financial year ended Dec 31. Even though the majority of investors may not look at those reports in detail (in fact, some investors may not even open the envelope containing the annual reports), some people will still spend time analysing the whole report. One of the key sections that investors will analyse in detail is the chairman’s statement and management discussion or operations review. In this article, we will label the above statements as management statements.

Most of the management statements will explain the companies’ immediate past one-year financial performance, external environment, major corporate developments as well as the companies’ future prospects.

Based on our observations, the majority of companies will try to explain and highlight a lot of positive elements that happened in the companies. It is very rare to find negative issues that affect the companies’ performances being discussed in the statements. Even though we cannot conclude that those companies that are willing to highlight their financial problems as good companies, at least these companies show their effort in trying to be truthful to their investors. This will provide a lot of plus points to these listed companies.

Analysts usually judge the quality of a company’s management team by looking at the comprehensiveness and truthfulness shown in the management statements.

Nowadays, if there are areas that a company does not comply with the accounting standards, the external auditor will highlight those areas inside the auditor report. Hence, investors need to read the management statements and financial statements together with the auditor’s report.

The management statements will normally provide the reasons driving the companies’ overall performance, whether good or bad. However, there are certain companies that tend to focus on higher sales and avoid mentioning the profitability when ever they report lower profits during the year. They will try to avoid the reasons causing the reduction in profits, for example, higher operating costs, raw material costs or stiff price competition.

Some times, some companies will claim they have managed to maintain profits at the same level as the previous year. However, if we further analyse the financial statements, we will notice that the profit had included a lot of exceptional items, such as gains from the disposal of fixed assets as well as investments. Hence, we should not rely on the explanation given by the management in the chairman’s statement.

In fact, we need to investigate further the driving factors for the profitability of the company, especially if it had included some exceptional gains or losses, which are not part of the company’s normal operations. These details can be found in the notes to the accounts. Normally, most companies will list the key items that affect their profitability in the notes to the “profit before tax”.

We can get a summary of key corporate developments that happened in the company in the “corporate development” section. If you have been following the company’s corporate developments, this section may not provide you a lot of new information.

Nevertheless, certain companies may provide the latest status of their corporate developments, such as any new projects being initiated or certain approvals from relevant parties being granted for their critical projects.
As for the section on the company’s future prospects, investors should not place too much weight on it. Based on our experience, a lot of Malaysian companies have the same statement on future prospects by saying that “the company will perform better in the future”.

There are companies that have reported losses every year but the chairmen will still say the companies would perform better next year without the backing of solid grounds to improve profitability.

Hence, a good company statement should provide a fair account of the actual happening in the company. In reality, it is quite difficult for listed companies to hide their problems as the level of financial literacy of the general public has improved over years.

There are some mature investors and analysts who are able to detect the problems faced by the company by analysing the notes to the accounts in addition to making comparison of the current financial statements versus the statements or quarterly financial statements of past years.

● Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting.

http://biz.thestar.com.my/news/story.asp?file=/2010/3/10/business/5827481&sec=business