How To Read A Company’s Annual 10-K Report Like A Pro?
You might be wondering who wants to read those hefty couple of hundred pages of annual reports, also known as, 10-Ks if there are so many sophisticated tools available online which can give you all the pertinent information in a few clicks? The fact that you have shown an interest in reading this article tells me something about you. You are a fundamental investor who knows that “the devil is in the details” and wants to gather as much information as you can before making any stock investing decision for the long-term.
The good news? You don’t have to read every single word. In this article, I will explain where you can find the company’s 10-K report and how you can be a smart investor by focusing on the key parts for red flags and skimming the rest.
If you’re a serious investor, you need to review a company’s Form 10-K.
Getting your hands on the 10-K
- Downloading from the Securities and Exchange Commission (SEC): The direct way to get the 10-K is from the SEC’s website. This is the official database of corporate filings required by the SEC. This assures you that you are looking at the same document as the regulators. Fig.1 below shows a screenshot of the SEC website where you can enter the company ticker to get its 10-K report.
- Downloading from the company’s website: Most companies will put an electronic version of their annual report to shareholders on their website. For example, fig.2 shows you a screenshot of obtaining the same 10-K report from The Coca-Cola Company’s website (Ticker: KO).
How to Tackle a Massive Annual Report?
Annual reports vary only slightly from company-to-company, however, you need to focus on the following key sections:
- Business: Here, the company describes in great detail about its business model, exactly what it sells, where it sells, and how it makes money. At times you can even find eye-opening facts about the company’s business. For instance, did you know that Coca-Cola sells a tea brand named Gold Peak in North America? Now you do.
Remember: As an investor, understanding the specifics of a company’s business model is critical.
- Risk factors: Just like cigarettes contain health warnings so do stocks. Companies must clearly specify everything that could possibly go wrong. Many of the risks are copy-pasted legal statements, but sometimes the warnings can be useful in your analysis.
Remember: Ignoring the risk factors in companies’ 10-Ks can be a big mistake.
- Unresolved staff comments: Usually the SEC specifies any issues related to any way the company handles its accounting in this section.
Tip: Make sure this part of the 10-K is blank. It is a huge red flag if the SEC disagrees with a company’s accounting and you should probably find another company stock to invest in.
- Legal Proceedings: There is always a chance for a company to get sued while running its business, especially big companies. You should keep an eye on lawsuits which the company feels could have an impact on earnings — good or bad.
- Consolidated Financial Statements: As an investor, you should look for rising sales, net profits and cash flow. You can read more about how to analyze an income statement here and a cash flow statement here.
- Management’s discussion and analysis (MD&A): This is the CEO’s unvarnished explanation of what has happened in the past year and the company’s prospects. If you notice something strange related to the company’s finances, for example, the cash flows are evaporating or the sales have slowed down, this section can tell you the cause and whether the problem is temporary or permanent.
Tip: When you see the word “challenging” in the MD&A language, that’s an indication that you need to dig deeper.
Scrutinizing the Footnotes
By reading the footnotes before reading anything else, you can quickly find out about all the unusual “things” going on at the company. It’s usually these unusual “things” that can affect a company’s future or health. Following are the key things you should dig for:
- Assets and liabilities that aren’t on the balance sheet: According to accounting rules, companies are permitted, for various reasons, to keep certain assets or liabilities off the balance sheet. As you can imagine, this can be a huge issue for you as an investor and you should take a closer look at this section. You can read more about analyzing a company’s balance sheet here.
- Understanding pension liabilities: Company’s footnotes usually disclose the size of the pension obligations. Pensions can take a huge chunk of profit remaining for the shareholders. Usually, if the company’s pension is underfunded, some of the shareholder profits are diverted to its pension plan. Pensions can also affect how much money a company can afford or allocate towards building new products, which can in turn slow down the company’s future growth.
- Changes to accounting and inventory: You should always be slightly suspicious and ask yourself why a company might decide to change its accounting treatment. A good way is to compare the accounting treatment with other companies in the same industry. Watch out when a company make its earnings look good by using accounting methods.
- Debt repayment timeline: You should always strive to understand whether a company has borrowed too much. One way to assess this is by knowing when a company’s debt matures, or is due. A company must either pay off the debt with cash, or refinance, by replacing the debt with a new loan at a higher current interest rates when the debt matures.
Examining What the Auditor’s Opinion Means For You as an Investor
- Auditor Changes or Disagreements: In case you find out that the company has changed auditors or says that it disagrees with its accountants, it is a huge warning that you may not be able to trust the numbers.
- Auditor’s Report: If the auditors question a company’s ability to stay in business, it is a red flag. Instead, you should always see some language which says that the financial statements represent the company’s financial position.
By reading this article, you should have a road map of what you need to do and look for in a company’s 10-K report. It will help you figure out information and determine the kind of things that companies can easily bury in these documents and hope it is not noticed by anybody.
Other Investing Articles by me
- How To Build Wealth Passively Using Dividend Reinvestment Plans?https://medium.com/swlh/the-snowball-effect-how-to-compound-your-wealth-using-dividends-d92b719ffe79
- Fundamental Analysis Using Company’s Income Statement: https://firstname.lastname@example.org/stock-investing-fundamental-analysis-using-companys-income-statement-37b0d80531f1
- Fundamental Analysis Using Company’s Balance Sheet: https://email@example.com/stock-investing-fundamental-analysis-using-companys-balance-sheet-153531d98f8b
- Fundamental Analysis Using Free Cash Flow Statement:https://firstname.lastname@example.org/stock-investing-fundamental-analysis-using-free-cash-flow-statement-454beaa7f00
- Fundamental Analysis Using Key Ratios: https://email@example.com/stock-investing-fundamental-analysis-using-key-ratios-ed02f32e88ae
Amrut is a Full Stack Software Engineer who is passionate about designing and developing web and mobile applications. He likes to write about technology, coding, investing, trading, finance, and economics. In his free time, Amrut likes to understand business models of publicly traded companies and analyze their financial statements. He strongly believes in adding value to people’s lives through quality work and empower people to take control of their personal finances.