What to look for in company filings
January 4, 2010Jon Brooks Comments Off
Take a look at this chart of the S&P 500, and note the big dip starting in 2000 and repeating in 2008. If you happen to be an investor who went on that roller coaster ride both times, you can probably be forgiven for being too dizzy to delve into the obfuscatory world of 10-Qs, 10-Ks, and other byzantine company filings mandated by the SEC in the interest of transparency.
Unfortunately, however, that may be the only way these days to get the real scoop on a company’s financial health. Investor outsourcing of crucial due diligence to the media, stock analysts, and even the ratings agencies led to massive losses in the accounting scandals early last decade and in the financial collapse later on.
So when it comes to your money, how can you trust anyone but yourself?
That’s the concept behind footnoted.org, which we highlighted in our last post. The site scours public SEC filings and looks for red flags that have been reduced to footnotes by companies looking to avoid investor scrutiny.
But what are those red flags, and how can the average investor find them? From Footnoted.org’s Inside Footnotes page:
Any investor who wants to pick their own stocks needs to feel comfortable reading, or at least skimming, a company’s 10-Q, 10-K and proxy statement. Investors should also pay attention to several other key forms, including 8-Ks, Form 4s (insider trading) and Schedule 13Ds. All of this information is available on the SEC’s Edgar database and on various subscription-based websites…
Once you become familiar with these documents, looking for a few key items shouldn’t take much time — figure around 30 minutes to skim a 10-Q or a proxy and an hour for a 10-K — and could save you a lot of money by helping you avoid potential problems.
Remember: there’s no need to read every word or even understand everything that you are reading. What you’re looking for are significant changes that were not in the filing last quarter or last year. What makes something significant? That’s difficult to say. It’s kind of like the way the Supreme Court defines obscenity: you’ll know it when you see it.
Also keep in mind that reading SEC filings is more of an art than a science. The language used in SEC filings — a mix of accounting-speak and legalese — takes some getting used to. When it comes to risk factors, for example, companies often list every conceivable possibility, even if the likelihood of that specific lightning strike is very rare.
With that in mind, here are a few suggestions on what to look for in these documents:
Quarterly:
* How does net income compare with pro-forma income? What is the company excluding to arrive at the pro-forma number and does it make sense?
* Are there any sizable differences between the numbers reported in the quarterly earnings release and the 10-Q?
* Does the company consistently report “special charges” quarter after quarter?
* What impact (if any) have restructuring charges had on the quarterly earnings?
* What impact (if any) have stock options had on the quarterly earnings?
* Have there been any significant changes to lawsuits that the company is involved in?10-K: (in addition to the above questions)
* Are the company’s deferred income taxes growing? What is the company’s effective income tax rate?
* Has the company made any changes in the way it recognizes revenue or accounts for its expenses?
* How is the company handling its debt? Is the new debt at favorable interest rates?
* What sorts of related party transactions is the company including and how does this compare to the disclosure in the proxy on related party transactions?
* What is the company including in its other assets/liabilities other income/loss? Are derivatives a substantial component of these numbers?
* How has stockholder’s equity changed over the past year?Proxy:
* How many times did the audit committee meet in the past year? Does the audit committee seem to have enough experience and independence to ask tough questions of company management?
* What types of related party transactions are being disclosed? Has there been a substantial increase in these transactions? Do they seem reasonable?
* How much stock do executive officers own? What about the directors?
* Do executive salaries correspond in any way to the company’s financial performance over the past year?
* Do the retirement benefits for executives (including pension benefits) seem excessive given the company’s performance?
* How much is the company paying its accounting firm for non-audit services? How does this compare to previous years?
* What sorts of shareholder proposals are being included in the proxy? Do they raise concerns about the company’s approach to corporate governance?
Not an easy task. But if you’re going to invest in individual companies in particular, perhaps this type of knowledge and time commitment is what it will take to feel confident you’ve got all the necessary info.
It’s interesting to note that footnoted.org now has a subscription site called FootnotedPro.
Designed for the sophisticated individual investor or advisor, this newsletter will deliver short takes on various filings – raising questions or pointing out hidden details, including new lawsuits, unusual executive changes, and questionable deals and disclosures that can be early indicators of potential problems or opportunities. It will also provide insight on significant trends in filings — and the opportunities they represent — that can only come from reading several hundred filings a day.
The price? $2500 per year. Yowsa. Nothing concerning investing is for the faint of heart these days…
