A prospectus is a document that’s used to attract potential investors, while an annual report is similar to a “report card” on a company’s performance.

A prospectus is a very in-depth document that goes into a company’s operating expenditures, capital, history, and lists of tangible assets. If you plan on buying shares in a company or fund that just made its Initial Public Offering (IPO), you’ll need to read through the prospectus.

An annual report on the other hand is meant to update shareholders on any major changes the company or fund is undergoing. Many investors choose to look through a company’s annual report (online) before buying shares.

What Do You Need to Look For?

When going through either document, there are four very important sections you should check out:

• The CEO’s Statement: This section condenses the major highlights of a company into a 1-3 page statement. When you read it, keep an eye out for keywords such as “new venture,” “despite (suggest mistakes),” ” consolidation,” “expansion,” and “reorganization.” If you read about the company’s move to a new country, market, or change in its products/services, it can mean the company’s either dealing with falling profits or it might have clueless management. Either way, make sure you check out the previous annual reports (up to 5 years back) to find out.
• The Auditor’s Report: When going through the auditor’s report, keep an eye out for keywords such as “contingent upon,” “subject to,” and “on condition.” If you see these terms, make sure you read the sentence very carefully to see if some important piece of financial info is being hidden.
• Financial Statements: Here is where you can find the real profits and losses of a company. Ideally, you should compare a company’s numbers over at least the last 5 years to find any inconsistencies such as earnings going up 4% but operating expenditures going up 12%. Also, evaluate why a company is making a profit. Is it because of innovation or because of layoffs or factory closures?
• The Balance Sheet: You’ll want to examine the debt/equity ratio of a company because it reflects the financial health of a company. Sometimes, a company may have rising earnings, but the earnings are outpaced by its borrowing. Also, there’s a chance that earnings will go into paying down debt, rather than dividends.
• Size of Issue: Included in the prospectus is how many shares a company/fund is issuing. More shares equates to lower demand and cost. Less shares equate to higher demand and cost.