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Keys To Reading An Annual Report

Keys To Reading An Annual Report

50 Key Concepts to help you understand the facts, and distinguish them from promotional puffery in an annual report (Barron's Business Keys)

by George Thomas Friedlob, Ph.D and Ralph E. Welton, Ph.D.

Keys To Reading An Annual Report by George Thomas Friedlob and Ralph E. Welton is a wonderful, little book for all investors. Each of the fifty, three-or-four-page sections covers a key concept that investors should understand when reading a public company's annual report and other financial statements.

Keys To Reading An Annual Report is no substitute for a complete text about financial statement analysis, such as The Analysis And Use of Financial Statements, but Keys To Reading An Annual Report is an excellent first read for new investors who are learning to understand financial statements. And, experienced readers of annual reports will probably find Keys To Reading An Annual Report a useful review.

Some of the fifty key topics covered include:

  • SEC Forms 10-K, 10-Q, and the 8-K
  • Current Assets
  • Cash and Receivables
  • Cost of Goods Sold and Inventories
  • Property, Plant, and Equipment
  • Depreciation
  • Intangibles and Other Assets
  • Depletion and Amortization
  • Current Liabilities
  • Bonds and Amortization
  • Owner's Equity
  • Classes of Stock
  • Treasury Stock
  • Discontinued Operations
  • Ratio Analysis
  • Taxes and Tax Deferrals

Many of the topics "Red Flag" things to which investors should pay special attention. For example, the chapter about Depreciation Red Flags: "The basis for long-lived asset valuation is historical cost. Because depreciation does not measure actual decline in value, the net book value of a long-lived asset (historical cost - accumulated depreciation) is not a good measure of the cost of replacing the asset. Neither is net book value a good measure of what the asset would bring if sold." (i.e., depreciation expense is a way of expensing the long-lived asset. And, the balance sheet only lists the so-called "unexpired cost.")

The red flag also discusses the difficulty in comparing depreciation across different companies because of the different ways depreciation may be computed.

The section about Treasury Stock tells us: "Stock Issued by a company may later be reacquired by the company. In some cases, the company may retire or cancel this stock. When reacquired stock is not retired or canceled, it is referred to as treasury stock." (there is a nice glossary at the end of Keys To Reading An Annual Report).

Friedlob and Welton point out that treasury stock is not an asset. "A company cannot create an asset by holding stock in itself."

However, because the reacquired stock may have been reacquired at a different price than it was originally issued, the wealth within the company can change in such a treasury stock transaction. For example, suppose stock is issued for $20 per share, but reacquired for $2 per share (it's an internet company!), then, somehow, the company has taken in $18 per share on the transaction. How is this accounted for in the financial statements?

Friedlob and Welton explain: "Just as treasury stock is not an asset, a loss or gain cannot result from treasury stock transactions. 'Things' happen that you and I would call a 'loss' (reacquiring treasury stock for $20 per share and later reissuing it for $12) or a 'gain' (reacquiring treasury stock for $30 per share and later reissuing it for $40). But it is illegal for a company to produce a gain or loss transacting in its own stock. When total stockholder's equity is decreased by treasury stock transactions (a loss), the decrease is generally taken directly from retained earnings. No loss is taken... When total stockholder's equity is increased by treasury stock transactions (a gain), the increase is recorded as a separate source of capital called Paid-In Capital from Treasury Stock Transactions."

So, by reading a little, two-page section about treasury stock in Keys To Reading An Annual Report, you probably now know more than 99% of all investors know about treasury stock!

Keys To Reading An Annual Report retails for only $4.95 and is 160 pages. If you are new to investing, you might also want to pick up a copy of Barron's Keys To Investing In Common Stocks, which is an excellent first read for investors.

Keys To Reading An Annual Report
Keys To Reading An Annual Report

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