A cynic was on the right track when he claimed, "The sumptuousness of a company's annual report is in inverse proportion to its profitability that year."
Investors contemplating the purchase of shares in a specific listed company can get hold of its latest annual report - either in hard copy by requesting a copy from the company or its share registry, or these days simply by downloading it from the Internet. The latter is faster and this approach also facilitates searching.
Such reports nowadays are usually quite bulky documents, typically containing 100 to 150 or so pages. The size comes about because of the requirements under the Corporations Act and the Listing Rules of the Australian Securities Exchange (ASX), and the need to comply with Australian Accounting Standards. Most "mum and dad" investors would probably not wish to devote the time needed for reading such weighty documents from cover to cover, so what should they concentrate on?
A good start might be to look at dividends, net tangible assets, earnings, the gearing ratio and the company's growth rate. Investors should focus on "per share" figures, rather than the millions of dollars totals which often make the headlines.
Each report will include a balance sheet, an income statement and a statement of changes in equity, amongst a lot of other information. Together these make up the financial statements (often just referred to as the company's "financials").
The annual reports will also contain a lot of additional information, including statements by the directors certifying the accuracy of the accounts and often also by the chief executive officer commenting on the results and the company's prospects. Also set out are detailed notes to the accounts and a report by the independent external auditors.
Dividends and net tangible assets figures are discussed in this Part 1. Earnings, gearing ratios and growth rates will be discussed in Part 2.
Dividends are important for investors in two separate ways - because of the clues they give as to the company's future prospects and because they tell the shareholders what cash they are going to get from their investment.
The latter aspect is particularly important for some categories of investor, such as self-funded retirees.
Only some of the total earnings available for a company's ordinary shares in respect of any one year are usually distributed to its shareholders in the form of dividends. The rest are "ploughed back", in other words retained in the business.
Dividing the total earnings (net of any preference dividends) by the total ordinary dividend payout for the year (interim plus final distributions) gives the "dividend cover" - a yardstick which gives a rough indication as to how secure the continuation of the rate of dividend might be.
The "dividend yield" is obtained by dividing the dividend figure (in cents per share) by the market price of the share (also expressed in cents).
However, dividing a historical dividend figure by a current market price can often be misleading, as the latter reflects investors' views of the future rather than the past.
Apart from that, it should be noted that the apparent annual return from ordinary shares as measured by the dividend yield is not at all comparable with the return from fixed interest investments, as the true return from shares includes the capital growth element.
Dividend declarations need to indicate the "franking ratio", in other words the proportion of the distribution which is franked and therefore associated with an imputation credit. For fully franked dividends the franking ratio is 100 per cent.
To make yields from franked dividends properly comparable with returns from alternative investments they should be "grossed-up" by multiplying by 1.429, in order to reflect the current 30 per cent company tax rate.
Net Tangible Assets
The "net tangible asset backing per ordinary share" figure, often abbreviated "NTA", is one possible measure of the worth of a share, although its usefulness is subject to some reservations. It can be compared to the market value of the share.
In an ongoing company the various measures related to income tend to be more relevant, as the asset backing of a share is not normally available to shareholders unless the company is placed in liquidation or makes a capital return, or unless a takeover offer reflecting this backing is made and accepted.
In any case, a company's assets are usually much more valuable on a "going concern" basis.
On the other hand, in the case of a company in financial difficulties and facing bankruptcy, the book values used for the assets may turn out to have been too high and not realisable under the fire sale conditions that are then likely to prevail.
Book values can also be too low rather than too high, particularly if assets have not been revalued recently in order to allow for inflation and the costs of replacement.
If there is only one class of ordinary shares then the "per share" figure is obtained by dividing the company's adjusted total net assets (gross assets less intangibles) by the total number of ordinary shares on issue.
A low NTA in comparison to the issue price of shares in a float is a prima facie indication that the promoters have been too greedy, at the expense of subscribers to the issue. This greatly increases the risk that these investors will be showing a loss once the new shares are listed.
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