The Finance Professor: Getting Started With Financial Statements

As you can see, there are no issues or red flags. The one accounting change ("Amylin Pharmaceuticals, Inc., changed its method of accounting for share-based payments...") was of a material enough nature to include in the report, but once you read the note to the financial statement you will understand that it is not a problem to be concerned with.

Step 2. Read the Letter From the CEO

The CEO (chief executive officer) is the leader of a company. In that capacity, not only does the CEO manage the current operations of the company, but he also sets the vision for the future. Thus, as an investor, what you want to hear from the CEO is where the company has come from, where it is and where it is going. On one end of the spectrum, some CEOs will use this section to cheerlead. On the other end, some will use it to be cathartic and talk about mistakes made and future challenges. Most CEOs' letters are somewhere in between.

Step 3. Check Out the Senior Management Team and the Board of Directors

The management team and board of directors will tell you who is operating and who is looking over the company. High on investor and regulator watch lists are concerns over corporate governance. You want to avoid companies with managers or board member who have tarnished or shaky backgrounds. As an example of the flip side of this, while the board of directors at Apple (AAPL Quote) has had to contend with options back-dating issues, the background of its members is highly reputable.

Step 4. Read the Business Overview

Companies will change over time. Its products and businesses will go through cyclical phases. Demand for old and new products and services will dictate future strategy. Economic and other market conditions will affect a company and industry.