Monday, June 29, 2009

The growing insignificance of the annual report

The month of June is an important month for investors. I am an investor myself, holding a portfolio of about 20 odd companies spread across diverse industries. I look forward to the month of June eagerly every year, for it is during this month that most companies dispatch their annual reports to their investors. The annual report contains details of the company’s performance during the financial year, which typically ends on the last day of March for most Companies. Hence it is quite natural for investors to be excited at the prospect of reading about all the happenings in their invested company in the past one year and to get critical insights about its prospects for the future. The annual report is supposed to be just that report. Yet if truth be told, nothing could be further to the contrary. Most, if not all, investors whom I know including myself give the annual report just a cursory glance before consigning it to the realms of the recycle bin. The contents of the annual report is not trash by any stretch of the imagination, yet the utter lack of usefulness of its content for investors year in and year out just defies common sense. Let’s look at the contents of a typical annual report to try and understand the reason behind this anomaly.

The first chapter of any annual report is an introductory statement by the Chairman of the company. The sole purpose of this statement is to create a feeling of warmth and generate goodwill amongst investors. Point taken, yet investors are better comforted by the warmth of wads of notes willowing in their wallets and the assurance of a repeat performance every year. Mere words and motherhood statements that find their way many a time into this section are a drag on investor patience. Hence the Chairman’s statement can be safely skipped without much risk.

Next follows the auditor’s certificate. Considering the fact that auditors are obligated by their profession to follow a boilerplate template while issuing this certificate, this section can be safely skipped as well.

Of late, many companies include a report on Corporate Governance which typically appears at this point in the annual report. In the name of Corporate Governance this report provides attendance records of the directors of the company at board meetings. In effect, investors are informed how many meetings are attended by directors but their contribution at such meetings is conveniently given the pass over. Hence this section is also worthy of skipping.

At this point, we reach the two sections which form the meat of any annual report – the financial statements and the management discussion and analysis. The financial statements and the associated explanations of the numbers that appear in numerous foot notes are about the most useful piece of information that one can find in an annual report. However, in this day of electronic updates, this data is already available on multiple financial web portals weeks before the annual report reaches the investor’s hands in physical form. This leaves the discussion and analysis section from our point and view. There is no defined format for this section. The quality and quantity of information revealed in this section varies with industry, company, management outlook and many other factors. If the company is interested in highlighting the drivers of the company’s performance, it should normally be found in this section. Many companies do try and give as much information as possible in this section about the drivers of their growth, now and into the future. Many others hold back in the fear of revealing sensitive company information. Still others are clueless about the reasons for their growth or lack thereof and end up making general risk free statements in this section.

Of the approximately 20 annual reports that I receive and read every year, I find a great difference in the thickness of these reports. I have read annual reports ranging from 15 pages to more than 150 pages. I have also observed that some companies follow the annual reporting process to the letter disclosing only as much as is legally required while a handful others try to go above and beyond the letter and try to comply with the spirit of annual reporting which is what investors are really interested in. The true spirit of annual reporting requires companies to not only analyze their past performance but also give a fair assessment of its future prospects based on the state of core competencies of the company and external economic conditions. Alas, this remains a distant dream as of now. Yet it can be done easily by including a section the Intellectual Capital of the company. A well designed Intellectual Capital Report that tracks the intangible assets and growth drivers of the company year on year is a good tool for informing investors about the inherent strengths of the Company. It will only take a few leaders to start disclosure of their intangible assets in this manner for the remainder to follow. The alternative is for the government to step in and introduce regulation requiring compulsorily disclosure of such information.

No comments: