Lessons From Your Mailbox, Redux

I recently offered some insights gathered from reading companies' annual reports. Well, the stack of reports on my coffee table has more companies worth examining, so permit me to resume my discussion.

Pfizer
I actually sold off my holding in Pfizer (NYSE:PFE) a little while ago, but the wheels were apparently still in motion for me to be sent its annual report. So since I had it, I glanced through it.

One thing I liked was that, front and center, the new CEO addressed shareholder concerns about the stock's lackluster performance in recent years. Jeff Kindler said that since he took over and a new management team was formed, "all our energies have been focused on improving the performance and prospects of the company -- and therefore on creating value for you." The most pleasing word to me in all that is "prospects," as it reinforces how critical a company's future is, especially a pharmaceutical company. New drugs need to be in development. Although not all will make it to market, if many are being explored, there are more chances of success.

Kindler went on to list many priorities, such as cutting costs, beefing up revenues, becoming more innovative, and developing more of an entrepreneurial spirit. This is helpful, because it tells shareholders what the firm will be working on and it gives some measures by which to evaluate future performance. In a year, for example, will revenue have risen? Will costs have fallen? Some goals, such as culture change, are harder to assess, but that's where some scuttlebutt investigations can help.

PepsiCo
I always enjoy perusing the annual reports of PepsiCo (NYSE:PEP), because they're so reassuring. They're filled with familiar products that I see people consuming every day -- soft drinks, water, salty chips and snacks, etc. Sales grow reliably, and the future is bright. Still, if you examine the report with a critical eye, you'll usually find some room for improvement. For example, volume growth in fiscal 2006 was an impressive 9% for the PepsiCo International division, but just 1% for both Frito-Lay North America (think Doritos, Tostitos, and Lay's) and Quaker Foods North America (Rice-a-Roni, Cap'n Crunch, Aunt Jemima, and more). Then there's shareholder return, which has been terrific over the long term in the past, averaging 15% annually over the past 20 years. But a graph in the report showing how shareholders did better with PepsiCo than with the S&P 500 from late 2001 to the end of 2006 isn't too convincing. The returns are actually rather close. Still, it's the future that matters, and investors need to assess how quickly the company will grow in the years ahead.

The report also offered interesting little nuggets like the company's "relentless focus on innovation, as new products consistently deliver 15% to 20% of our total growth." Also, PepsiCo has "17 mega-brands, each of which delivers retail sales of at least $1 billion." (Five of them top $5 billion.) Equally encouraging is the fact that non-carbonated beverages are growing briskly in popularity, making up 38% of PepsiCo's volume and 69% of its revenues (in the U.S. and Canada).

3M
I'm a relative newcomer to 3M (NYSE:MMM), and was pleased by the candor in the CEO's letter to shareholders. Check out what George Buckley has to say: "But in the euphoria of driving out waste, expectations that [3M's Lean Six Sigma focus on manufacturing efficiency] would continually deliver more capacity were sometimes overestimated. ... This overestimation led to demand and capacity imbalances, with the largest divergence naturally emerging in those businesses with the highest growth rates." He went on to explain how the company is investing in more capacity to meet higher demand. He then addressed challenges in supply chain management, concluding, "Going forward, 3M's default model is to make our supply chains short and close to customers."

I also found another section of his letter instructive to investors in general. Buckley noted that acquisitions at 3M are not just about increasing volume; different purchases are made for different reasons, such as advancing a technology base, filling product lines, gaining immediate new capacity, gaining access to new markets, strengthening the core business, and growing in adjacent areas. I was happy to see him add, "But they will always be about getting a sensible return on investment."

Berkshire Hathaway
We've covered Warren Buffett's company Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) many times in Fooldom, including the brilliance of his unusual letters to shareholders. I sometimes like to review management's discussion of risks facing a company, though, which is generally included in the 10-K reports that accompany most annual reports. We who hold Berkshire Hathaway in the highest regard can sometimes ignore possible risks, so I thought I'd remind myself of some of them. Here are a few I found listed in the Berkshire annual report:

• Because of interest rate risk, if interest rates rise, the value of the company's investments in bonds and other interest-rate-sensitive instruments is likely to fall.
• Berkshire's stock holdings are rather concentrated, and a significant drop in equity prices will lead to a drop in shareholder equity. Mr. Buffett went further, offering specific estimated examples. (A 30% drop in market prices, for example, could lead to an 11% drop in shareholder equity.)
• Due to some of the company's holdings, it's also exposed to foreign currency risk (the dollar is not the only currency that goes up and down, after all) and commodity price risk (such as the price of electricity and natural gas).

Most annual reports offer both promise and risks. It's up to us investors to decide whether the expected benefits outweigh the risks.

In sum
If you're interested in any of these companies, I encourage you to seek out their annual reports, read them carefully, and also check out those of their competitors.

In the meantime, if you're looking for some promising companies to add to your portfolio, check out our Motley Fool Inside Value newsletter. It's given me some great investment ideas over the years. A free trial will give you full access to all past issues, enabling you to read in detail about dozens of contenders, including some I've discussed in this article.

Longtime Fool contributor Selena Maranjian owns shares of 3M, Berkshire Hathaway, and PepsiCo. 3M, Berkshire Hathaway, and Pfizer are all Motley Fool Inside Value recommendations. The Motley Fool is  Fools writing for Fools.