It pays to read between the lines of the glossies

A slickly presented annual report can give a deceptive picture of a company. Shareholders should take a closer look

One effect of all the privatisation and demutualising plus the popularity of PEPs and ISAs is that a lot of us now get annual reports from companies. Along with them comes the chance to vote before or during the annual general meeting. The thud on the mat is a bore and chore for many, who might also wonder about the threat to trees, but the law obliges a PLC to publish certain facts and figures. Of course, some large companies send only what they call an annual review, daring the small shareholder to request his or her full rights.

One effect of all the privatisation and demutualising plus the popularity of PEPs and ISAs is that a lot of us now get annual reports from companies. Along with them comes the chance to vote before or during the annual general meeting. The thud on the mat is a bore and chore for many, who might also wonder about the threat to trees, but the law obliges a PLC to publish certain facts and figures. Of course, some large companies send only what they call an annual review, daring the small shareholder to request his or her full rights.

The utilities and one-time building societies are good at this technique which can downplay gloomy news and conceal awkward facts such as what the directors are up to with shares in their own companies. They may have bailed out, sold at a profit or bought options on the cheap. On the other hand, it does save on postage and reading.

After all, the institutions that own 73 per cent of companies' shares, on average, will scrutinise the complete version (Barclays' latest runs to 183 pages). So will other experts, ranging from accountants and analysts to competitors and custodians.

Any howlers or scandals are likely to emerge in the financial press (HSBC's $1bn lawsuit was buried in the annual report) especially if the annual general meeting proves stormy. Remember the pig photographed outside the London Arena when Sid and his pals accused British Gas of overpaying its bosses.

At all events, small investors do well to scan the yearly accounts, noting the key figures and foreword. (Research by ProShare in May 1999 suggested only one in four investors bothered.) That way they may realise they should sell out or that more shares can be had instead of the dividend.

This is one of the three main items, along with profit and turnover, that indicates how the company is performing. Gross income, for instance, should be rising with inflation or expansion. The pages that follow may add some hint of how output compares with the past.

Second, go down the layers of profit (if there are losses, they are usually shown in brackets) to what is called the bottom line. This last is the net or retained profit, and the way it is calculated can be complicated. The point is that the gross or overall profit is before all kinds of deductions such as tax, transfers to subsidiaries and also the reward distributed to loyal and sometimes long-suffering shareholders.

It is natural to look at this first, but be warned. Even in bad times companies will strive to increase or maintain the dividend. Halving it means nasty headlines - and if shareholders get nothing at all, the big boys may tell directors to go. Continually upping the dividend may involve borrowing cash, selling assets or taking money out of the reserves, which is a reminder that the annual report measures a stock as well as a flow. It is like your own cashbook or spreadsheet that lists the value of your savings, investments and property along with salary and outgoings over the past year. The company's land, machinery and materials certainly have their price, but assets hardly help cashflow if the warehouse is full of half-made or unsold products because of a strike or slump or sheer obsolescence.

Besides inventories and depreciation, experienced shareholders will look for other tell-tale trends such as gearing: the ratio of borrowed money to capital. So-called exceptional items can be another giveaway.

Take the example of Muddlethrew PLC whose twin plants, making mud-pies, always earned a net £1m, which was totally distributed to shareholders. Last year saw the same figure - but wait a bit! There was an exceptional item: the sale of one factory for half that amount. Since mud-pies must be going out of fashion, next year's pay-out will not even reach £500,000.

Canny or cynical investors will also cast a jaundiced eye over the glossy paper and production - which, of course, is where the folksy, friendly annual review comes into its own with its picture of smiling staff and happy customers. Even the annual report usually shows grinning directors. Company law should oblige them to stare gloomily out of the pages when profits decline or even be photographed with blankets over their heads after a thumping great loss.

A PR agency can do wonders with design. The simplest trick is to select highlights in bold words with rosy figures.

HIGHER ASSET GROWTH. DIVIDEND ABOVE AVERAGE. EXPORTS DOUBLE AGAIN. The board hopes that most readers will not have a calculator handy to note that profitability has declined or that operations abroad are a small, speculative part of a business whose domestic margin or market share is under pressure.

Veteran shareholders will study the introductory overview which may cover two pages before a brief aside in the penultimate paragraph that no dividend will be paid. Learn to decode the message from the chairman or chief executive, starting with the fact that if the titles are combined, it may be an unhappy ship.

Alliance & Leicester's captain does not tell us that his last lieutenant walked the plank; and it is only on page 71 that shareholders might notice the degree to which bad debts have soared since 1996.

Things are getting worse when a chairman mentions "a further challenging year". If the company is "repositioning", it clearly took a wrong turning recently. Where a venture "performed as expected", it has yet to make real money.

If you cannot spot something wrong, put a ring round some obscure item in the accounts and write to the company secretary for an explanation. I once asked Equitable about its reinsurance and discovered it was no longer a pure life office.

Finally, do use your vote even if the insert obliges you to find some scissors or remember a reference number. Most individuals do not post their proxy form, assuming that the outcome is a foregone conclusion.

Finola Healy of ProShare says, "Private investors would do well to attend, but our survey shows that 80 per cent do not bother, partly because the venue is too far away."

Yet you can still keep directors on their toes with a message in the pre-paid envelope. I regularly wrote BLACKBURN MUST GO on my Halifax form, until Mike Blackburn, the former chief executive, went.

As far as the board is concerned, sceptical shareholders may be anything from lawyers to customers. They may complain to authorities or even stand for election - as building societies know too well.

I know at least one other shareholder - in Southampton - who rejects all resolutions on the voting form in the spirit of the immortal Groucho Marx with his: "Whatever it is, I'm agin it!"