How do you read a company’s annual report?
It’s a question I often get.
The renowned value investor Mohnish Pabrai was recently asked that exact question in a YouTube video. Luckily for us, he answered.
This is obviously very valuable information, as he is a gifted value investor and any insight into how he invests is a gem of wisdom.
Most people think that “reading an annual report” boils down to calculating the intrinsic value of the company.
Mohnish Pabrai’s approach shows that this is far from the most important thing.
Here are five things he looks at before even diving into the financial numbers.
1. He Checks If Any of the Gurus Have Invested in It
Mohnish Pabrai admits to copying other value investors shamelessly.
He considers himself to be a good “cloner”.
The first thing he does when he gets a curious about a company is to check who has already invested in it.
“Hopefully someone smarter than me already who owns shares in the company,” he says.
This is a funny statement, as I think it’s hard to find anyone more intelligent than Mohnish Pabrai.
You can check whether some of the big value investors have invested in a company at www.gurufocus.com, www.dataroma.com or www.whalewisdom.com.
2. He Reads the Writeups about the Company
If the large value investors have shown interest in the company, there are probably also writeups online.
What do they say about the company? Do you agree with the analyses? These are good places to start forming an opinion
3. He Reads All the Shareholder Letters
At the beginning of an annual report (or sometimes as a separate document) you will find a letter from the management to the shareholders, also referred to as the shareholder letter.
In this letter, the director and/or chairman of the board gives a broad overview of the year that passed and talks about what they are working towards in the future.
It gives a great bird’s eye view of the company’s development and future.
Mohnish Pabrai’s assistant collects all the previous shareholder letters in a PDF file, and then he starts reading them chronologically. I imagine that he reads them from a print-out.
I know he has his assistant print out all emails in the morning. He doesn’t seem keen on reading off a screen.
What should you look out for?
First of all, it’s important that the letters are honest and understandable.
It’s important that these letters are not written by a PR agency, but written in the management’s own language.
How can you tell the difference? You can tell from the style.
Does it sound like something someone would actually say, or does it sound like clichés?
If the letters are not intelligible, it’s a blinking warning light.
Maybe they’re hiding something from the shareholders?
Management must communicate honestly and in simple and straightforward language.
Secondly, you should look at whether the management can keep its promises to the shareholders.
Mohnish Pabrai investigates how the management and the company have performed in relation to what they promise in the letters.
Here you have to remember that they don’t know the future. For instance, the companies knew nothing about coronavirus and shutdowns when they filed accounts before COVID-19.
4. He Reads a Transcript of Their Earnings Calls
Shortly after a report, management answers questions from investors and analysts. You can find this on the company’s website under investor relations, with the header webcast or earnings call.
Mohnish Pabrai reads the transcript of all the earnings calls. He doesn’t say, but again I imagine that he has his assistant collect all of them in a PDF and print them, so he can go through them chronologically.
He browses through the initial presentation – which is mostly management’s repetition of the financials – and pays more attention to the Q&A part.
What does management say about the future and how honest are they when answering questions?
Does management tend to overpromise and underdeliver? Or underpromise and overdeliver?
It says a lot about what you can expect in the future.
5. He Looks at the Company’s Proxies
Mohnish Pabrai recommends that you read the company’s proxy statements.
In the proxies you can find the shareholders’ proposals for changes.
These documents give you an idea of whether the company operates in a shareholder-friendly way.
You can usually find the company’s proxy statements on the company’s own website on the investor relations page.
Sometimes you find them under “other announcements” and other times they call them “proxies”.
For the US companies, you can also look them up on SEC.gov as DEF14A and DEFa14A notices.
Only then does Mohnish Pabrai dive into the annual report itself to look at risk and competition and run through the numbers.
You can read much more about what to look for in an annual report in my e-book Free Yourself.
There I show you, among other things, how you can work out whether the company is worth more or less than what it is traded for on the stock exchange.
Don’t forget to download my e-book Free Yourself where you’ll learn to invest as one of the best – super charge yourself through the plateaus. You can download it here.