Find Clues to Success in Annual Reports

Physician's Money Digest, January31 2004, Volume 11, Issue 2

Companies are famous for doctoring their annual reports to make their performance seem better than reality. To find out a company’s actual performance, you need to look beyond the income statement provided in an annual report, according to BottomLine Personal. Get out your magnifying glass and learn to hunt for clues by digging deep into financial statements. Forensic accounting does not require a CPA, but physician-investors do need to do a little Internet investigating to find a company’s balance sheet, which is usually found in quarterly and annual reports. You can also download balance sheets for free through the Securities and Exchange Commission (www.sec.gov). Why is a balance sheet important? It reflects the financial health of a company by reporting its assets, liabilities, and shareholder equity. First examine inventory, which should grow at about the same rate as sales. Next compare total liabilities with the previous year. Companies whose debt is stable or decreasing are good bets. Stay away from companies that report a rise in short-term borrowing. Another danger sign: a rise in deferred tax liability, which signifies taxes owed and unpaid. Keep in mind that many companies keep one accounting book for shareholders, and another for the IRS. Check the footnotes of an annual report for a reconciliation that breaks down deferrable taxes vs currently payable. Also look for steady or rising retained earnings, which mean profits have been reinvested in the company regularly. If all of these clues add up, you’ve found a successful stock.