Q&A Dominic Coyle
Getting an accurate read on company annual reports
I am the holder of some equity shares and receive a copy of the annual report of the company. I like to peruse the report, particularly the highlighted results but have a continuing problem in understanding the meaning of and significance of such term as “Free cash flow”, of “Ebidta”, of “earnings per share”, etc. Can you please recommend a book which in simple English defines and explains basic business report terms and also hopefully gives some information on how to interpret those terms?
Mr J.M., Westmeath
Annual reports are, in general, the revenge of a company on shareholders for their temerity in seeking a bit of transparency about their investment. More often than not, outside the studiously reassuring words of the chairman’s statement, they use language designed either to be so bland as to mean nothing or so arcane as to intimidate the humble shareholder and ensure they ask no awkward questions at an annual meeting, assuming they are bloody minded enough to attend.
As we now know to our cost in relation to the banking sector, some are effectively useless at giving shareholders an accurate read on the company in which they are investing. In my experience, the vast majority do little more than trot through already freely available public information on a company. For most people, the single point of interest is the confirmation of the pay levels of their company’s directors. Though US company filings do tend to be somewhat more informative, they are no more user-friendly than their UK or Irish counterparts.
Part of the problem for ordinary investors, as you say, is that they are constantly stumbling across terms, of whose meaning they are unclear, such as some of the ones you mention.
Ebitda, for instance, is a measure of a company’s earnings. However, it looks at earnings without taking account of interest payments, tax, depreciation and amortisation. A sceptical article in Forbes likened Ebitda to a blender “into which go normal financial statements and out of which comes a number that always seems to make the subject company look better than it did when the numbers went into said blender”. To confuse matters further, some companies quote Ebit.
Where is can be useful is measuring like for like operating cash flow performance for large companies within the same sector, assuming they all report using Ebitda.
Free cash flow is a measure of the cash a company has left after paying its expenses and capital expenditure costs. However, it too is not a straightforward good/bad measure. For instance, a smaller company investing heavily in growth could have negative cash flow but still be performing strongly.
Still, it can give a measure of the potential for a company to invest in expansion, accelerate debt payments or issue dividends.
Earnings per share is another measure of profitability – this time indicating the amount of profit per share in the company. It is considered a fundamental measure of profitability and is normally indicated in cent or pence per share. But, once again, you need to know exactly what is being measured. As the shares in issue can change at any point during a reporting period, it is more accurate to measure the weighted average number of shares in issue over the course of the year – but does the company whose report you are looking at do so? Also, you need to be aware of the niceties between earnings per share and diluted earnings per share (which take account of shares held by way of warrants outstanding or convertibles).
There are several books on the market to offer some guidance to unsophisticated investors. Depending on their provenance, some are more useful for investors in UK shares; others for those investing in the US markets. But, in truth, guidance on most of the terms that you will come across in the regular quarterly updates, or annual reports, of a company is most readily available on the internet.
This column is a reader service and is not intended to replace professional advice. Please send your questions to Q&A, c/o Dominic Coyle, The Irish Times, 24-28 Tara Street, Dublin 2, or to firstname.lastname@example.org