Auditor’s Reports, Promoter’s Shares Pledged and Management Discussion

by Manshu on April 6, 2011

in Opinion

There are a lot of people who are interested in picking stocks for their portfolio, and while I’ll not recommend this to people who are not willing to do a lot of research on their own; if you are interested in analyzing companies then there are three things that you must read.

Auditor’s Report: Every annual report has got a section called Auditor’s Report which is usually 2 or 3 pages long. In this section the auditors comment on the company’s financial statements and state any irregularities that they see.

Usually, you won’t find anything here, but every once in a while you will come across some comments from the Auditors about how something should have been done differently.

For example – they may say that the foreign currency loans have not been revalued, and had they been revalued the profits of the company would be lower by $10 million. This is a red flag and should make warning bells go in your head. I’m not saying this should be the basis to reject a company, but if you’re going to own a stock you should know about these kind of things.

Promoter’s Shares that have been pledged: In the financial statements you will find disclosure on whether the promoter of a company have pledged their shares.

Pledging shares by the promoters is mortgaging stake in the company to raise money, and if the promoters have to do that then that’s usually not a good sign. Again, this is not something to reject the company on its own, but something that you should be aware of.

Management Discussion and Analysis: This is another section of the annual report in which the company discusses its current situation and discusses its future prospects. Since the management writes this you can expect them to be on the optimistic side, but as a small time investor this is a good way to understand what strategy the company employs and whether you agree with that or not.

You should view the positive tone of the Management Discussion with a little bit of skepticism since it’s only natural that they are gung-ho about their business, but other than that – this will give you a good flavor of how the management is thinking.

Sometimes, this section also has some interesting observation about the industry as a whole with good numbers, and that can be useful if you’re trying to understand an industry or a sector.

Reading these three sections won’t take more than 30 minutes of your time, and if you’re going to buy stocks then you owe it to yourself  to spend these 30 minutes.

Let me reiterate what I said at the beginning now – picking stocks is not for everyone, and you should have good reasons to think that you can beat the market or the good mutual funds that have been around for years. Most people won’t be able to do that and are well advised to stick to mutual funds. This post is only for the few who have the time and interest to do their own research and are interested in stock picking for their portfolio.

{ 3 comments… read them below or add one }

Indian Thoughts April 8, 2011 at 12:18 AM

One of the very useful article.. thanks for sharing this all information..

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Manshu April 8, 2011 at 10:58 AM

Thanks – glad someone found it useful. There was some news about KEC today, and I did a quick read of the management discussion and was surprised to learn so many new things there. Not only about the company, but the industry as well.

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Anish July 27, 2014 at 7:16 PM

Excellent

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