Notes

I struggled reading annual reports

You know what was a game changer?

The 6-step framework from Aswath Damodaran

You can steal it here:

Have clear goals

Always know why you are reading an annual report. What's your purpose?

Here are 5 essential things:

- Cash Flows
- Investments in Future Growth
- Operational Efficiency
- Quality of Earnings
- Risk

1️⃣ Cash Flows

- How much revenue is translated into cash flow?
- How much capital does the company need to generate these cash flows?

Free Cash Flow per share growth is one of the main drivers for stock prices.

2️⃣ Investments in Future Growth

- How much growth is generated by increased productivity?
- How much growth CAPEX does the company use?

3️⃣ Operational Efficiency

- How efficiently does the company allocate capital?
- Does management put a lot of emphasis on operational efficiency?

The better the capital allocation skills of management, the better for you as an investor.

4️⃣ Quality of Earnings

Not all earnings are created equal

Look for:
- Amount reinvested
- Return on invested capital (ROIC)

5️⃣ Risk

There are two primary concerns regarding risk:

- Operational risk involves issues related to the core business activities of the company.
- Financing risk pertains to challenges associated with the company's funding methods.

Now you know what you're looking for and why, you can start using Damodaran's 6-step approach.

Step 1:

Confirm the timing and currency

- What period is covered?
- What currency are they reporting in?

Step 2:

Map the business mix:

- In which segment does the company operates?
- What does the geographic breakdown look like?

Step 3:

Find the base inputs for valuation

From the Balance Sheet:

• How much debt the company have?
• Does the company have more current assets and current liabilities?
• Does the company have a lot of goodwill on its balance sheet Image
From the Income Statement

• Are revenues steadily increasing over time?
• Does the company need a lot of COGS to sell its products?
• How much revenue is translated into net income?

From the Cash Flow Statement

• Are most earnings translated into operating cash flow?
• Does the company have a positive free cash flow (operating cash flow – CAPEX)?
• Did the company manage to increase its cash position compared to last year?

Step 4:

Keep digging

In the footnotes look for:

- Does the company use a lot of SBCs?
- When does the company's debt mature?
- ...

Step 5:

Confirm The Units

- How many shares outstanding does the company have?
- Does the company have preferred shares?
- Are acquisitions paid with stocks?

Step 6:

Corporate Governance

- Do insiders get special privileges?
- Does management have a lot of skin in the game?