The ARS is a firm's annual report to shareholders. It carries
fewer regulatory requirements than the official annual report to the SEC, Form 10-K. Some annual reports veer more toward advertisement than rigorous financial document, however. Most ARS reports consist of a letter from senior managers laid out on glossy paper, often with attractive photos of the company's customers, employees and products — some of the most diverse
workforces and cleanest hardhats you'll ever see. The firm's 10-k is often stapled into the crease.
The Rules
Companies can use less technical language in the ARS letter
than in the 10-k. This has potential advantages (the letter tends to be more readable than anything in the 10-k) as well as potential disadvantages (it may be little more than a sales pitch). Some managers seize the opportunity to
communicate openly and honestly with stockholders and potential investors;
others don’t. “The annual report is one of the only places a firm’s managers
talk directly to you,” says Alex Motola, manager of the Thornburg Core Growth
fund. “Read what they have to say — and take it with a grain of salt.”
What to Look For
In short, the best annual reports use straightforward
prose to tell you about the roses and the thorns. Look for:
Candor. The company shouldn’t just pump up its
accomplishments and advantages; it also should describe its shortcomings and
how it intends to overcome them. Google begins its annual report with a letter
from company founders Sergey Brin and Larry Page. Their 2007 letter included
the following passage:
Our advertising system works well, but we still have
tremendous opportunities to improve it. For example, I just did a search for
natural swimming pool, which returned eight right-hand-side ads, with only the
last two of those somewhat relevant.
True, the letter goes on to explain that the results are
both good and bad news: While it’s bad that only a quarter of the ad results
were relevant, it’s good there were some relevant ads for such an unusual
search — and the founders think the company can make a lot more money as it
improves its ad-targeting system. But at least they admit some failings.
Other companies are less forthcoming. Take
agricultural firm Archer Daniels Midland’s 1998 report, ranked the year’s worst
by Chief Executive magazine. The one-page letter from management failed to
mention the fact that three top ADM executives had been convicted in a massive
price-fixing scheme. Instead, it offered up mush such as “Think of ADM as an
extension of the farm” and “The right to be well-fed is a basic human right.”
Readability. The firm’s management should approach the letter as
an opportunity to help you understand the company as well as possible, using
prose that’s clear and engaging. You want to feel that company execs respect
shareholders as partners. A dismissive or patronizing tone is a red flag.
Warren Buffett’s letters to Berkshire Hathaway (BRK-A)
shareholders are famously good reads. You can find them here [link to
href="http://www.berkshirehathaway.com/reports.html">http://www.berkshirehathaway.com/reports.html].
The letters written by National Beverage Corp. Chairman and CEO Nick Caporella are
entertaining on another level. Consider this excerpt from the company’s 2005
report (ellipses and italics are original to the letter):
And so…a full-fledged revolt by the sophisticated beverage
consumer developed with a fervor…that has forever realigned the consumers’
demands…a new tasteful evolution is underway! Full swing — as they say.