When you pick up a company’s Annual Report, especially in this part of the world, it quickly becomes clear if they’re trying to help you understand their business; or not. [The same is also true for IPO prospectuses, BTW.]
However does clarity, or a lack of it, provide a reliable guide to future stock returns?
Using a modified (for Chinese characters and inclusion of graphics) Gunning Fog Index the team of Minggen Gong, Yifei Lu and Jing Yao from the School of Economics at the Fudan University set out to see if hard to read Annual Reports from Chinese companies led to subsequent stock under-performance; and they do.
They note previous work that failed to draw the same conclusion from a study of U.S. data. They suggest different calculations of opacity, with theirs including a test for graphics, and the nature of emerging versus developed market norms in terms of information give up may be the reason for this?
The bottom line for investors looking to stay out of trouble is look for clarity, short sentences, absence of difficult words, charts and brevity in Annul Reports [And all other publications I’d add]. If it looks like a company is trying to hide something then at least in China, chances are, they are.
The paper is an easy to digest 8-pager and can be accessed via this link Annual Report Opacity and Stock Returns.
Happy Sunday.