Chapter 12
IN THIS CHAPTER
Paging through an annual report
Reviewing other information sources for a second opinion
Organizing your own research library
Financial documents — good grief! Some people would rather suck a hospital mop than read some dry corporate or government report. Yet if you’re serious about choosing stocks, you should be serious about your research. Fortunately, it’s not as bad as you think (put away that disgusting mop). When you see that some basic research helps you build wealth, it gets easier.
In this chapter, I discuss the basic documents that you come across (or should come across) most often in your investing life. These documents include essential information that all investors need to know, not only at the time of the initial investment decision, but also for as long as that stock remains in their portfolio.
When you’re a regular stockholder, the company sends you its annual report. If you’re not already a stockholder, contact the company’s shareholder services (or investor relations) department for a hard copy or to get a copy emailed to you. Virtually all the websites for public companies have publicly filed documents (or links to where they can be found at the Securities and Exchange Commission, or SEC).
You can also often view a company’s annual report at its website. Any major search engine can help you find it. Downloading or printing the annual report is easy.
www.prars.com
to order a hard copy or to www.annualreportservice.com
to view reports online. This organization maintains an extensive collection of annual reports.www.wsj.com
).You need to carefully analyze an annual report to find out the following:
Your task boils down to figuring out where the company has been, where it is now, and where it’s going. As an investor, you don’t need to read the annual report like a novel — from cover to cover. Instead, approach it like a newspaper and jump around to the relevant sections to get the answers you need to decide whether you should buy or hold onto the stock. I describe the makeup of the annual report and proxy materials in the following sections.
Not every company puts its annual report together in exactly the same way — the style of presentation varies. Some annual reports have gorgeous graphics or coupons for the company’s products, whereas others are in a standard black-and-white typeface with no cosmetic frills at all. But every annual report does include common basic content, such as the income statement and the balance sheet. The following sections present typical components of an average annual report. (Keep in mind that not every annual report presents the sections in the same order.)
The first thing you see is usually the letter from the chairman of the board. It’s the “Dear Stockholder” letter that communicates views from the head muckety-muck. The chairman’s letter is designed to put the best possible perspective on the company’s operations during the past year. Be aware of this bias; no one in upper management wants to panic stockholders. If the company is doing well, the letter will certainly point it out. If the company is having hard times, the letter will probably put a positive spin on the company’s difficulties. If the Titanic had had an annual report, odds are that the last letter would have reported, “Great news! A record number of our customers participated in our spontaneous moonlight swimming program. In addition, we confidently project no operating expenses whatsoever for the subsequent fiscal quarter.” You get the point.
This section of an annual report can have various titles (such as “Sales and Marketing”), but it generally covers what the company sells. You should understand the products or services (or both) that the business sells and why customers purchase them. If you don’t understand what the company offers, then understanding how it earns money, which is the driving force behind its stock, is more difficult.
Are the company’s core or primary offerings selling well? If, for example, the earnings of McDonald’s are holding steady but earnings strictly from burgers and fries are fizzling, that’s a cause for concern. If a business ceases making money from its specialty, you should become cautious. Here are some other questions to ask:
Look over the various financial statements and find the relevant numbers. Every annual report should have (at the very least) a balance sheet (for the beginning of the year and the end of year), three years (typically) of income statements, and cash flow statements for the years in question. Catching the important numbers on a financial statement isn’t that difficult to do. However, it certainly helps when you pick up some basic accounting knowledge. Chapter 11 can give you more details on evaluating financial statements.
First, review the income statement (also known as the profit and loss statement, or simply P&L). It gives you the company’s sales, expenses, and the results (net income or net loss).
Next, look at the balance sheet. It provides a snapshot of a point in time (annual reports are required to provide two years of year-end balance sheets) that tells you what the company owns (assets), what it owes (liabilities), and the end result (net worth). For a healthy company, assets should always be greater than liabilities.
The summary of past financial figures gives you a snapshot of the company’s overall long-term progress. How many years does the annual report summarize? Some reports summarize three years, but most go back two years.
The annual report’s management issues section includes a reporting of current trends and issues, such as new developments happening in the industry that affect the company. See whether you agree with management’s assessment of economic and market conditions that affect the firm’s prospects. What significant developments in society does management perceive as affecting the company’s operations? Does the report include information on current or pending lawsuits?
Annual reports typically include comments from the company’s independent accounting firm. It may be an opinion letter or a simple paragraph with the accounting firm’s views regarding the financial statements.
The company identity data section informs you about the company’s subsidiaries (or lesser businesses that it owns), brands, and addresses. It also contains standard data such as the headquarters’ location and names of directors and officers. Many reports also include data on the directors’ and officers’ positions in stock ownership at year’s end.
The stock data section may include a history of the stock price, along with information such as what exchange the stock is listed on, the stock symbol, the company’s dividend reinvestment plan (if any), and so on. It also includes information on stockholder services and who to contact for further information.
As a shareholder (or stockholder — same thing), you’re entitled to vote at the annual shareholders meeting. If you ever get the opportunity to attend one, do so. You get to meet other shareholders and ask questions of management and other company representatives. Usually, the shareholder services department (or investor relations department) provides you with complete details. At the meetings, shareholders vote on company matters, such as approving a new accounting firm or deciding whether a proposed merger with another company will go forward.
If you can’t attend (which is usually true for the majority of shareholders), you can vote by proxy. Voting by proxy essentially means that you vote by mail or electronically. You indicate your votes on the proxy statement (or card) and authorize a representative to vote at the meeting on your behalf. The proxy statement is usually sent to all shareholders, along with the annual report, just before the meeting.
A wealth of valuable information is available for your investing pursuits. The resources in this section are just a representative few — a good representation, though. To get a more balanced view of the company and its prospects (instead of relying only on the annual report that I describe in the preceding section), take a look at several different sources of information for the stocks you’re researching.
The serious investor doesn’t overlook the wealth of information that he can cull from documents filed with the SEC. Take the time and effort to review the documents in the following sections because they offer great insight regarding a company’s activities.
Here’s how to obtain the main documents that investors should be aware of:
Visit the SEC, either in person or online. These documents are available for public viewing at the SEC offices. You can find out more by contacting the Securities and Exchange Commission, Publications Unit, 450 Fifth St. NW, Washington, DC 20549.
At the SEC’s website (www.sec.gov
), you can check out EDGAR (the Electronic Data Gathering, Analysis, and Retrieval system) to search public documents filed. It’s a tremendous source of documents that date back to 1994. You can search, print, or download documents very easily. Documents can be located either by document number or keyword search.
Gee, how intimidating. Just the report name alone makes you scratch your head. To some people, 10K refers to running a race of 10 kilometers. But if you’re reading a 10K, you may wish you were running one instead.
Form 10K is a report that companies must file with the SEC annually. It works like the annual report that you get from the company, except that it provides more detailed financial information. It can be a little intimidating because the text can be dry and cumbersome. It’s not exactly Shakespeare (although 10K reports would’ve also driven Lady Macbeth insane); then again, the data isn’t laden with as much spin as the annual report the company sends to shareholders. Without going crazy, go through each section of the 10K. Take some extra time to scrutinize the section on financial data. Ask the same questions that you do when you’re looking at the annual report.
www.investopedia.com
)www.investor.gov
)www.last10k.com
)www.secinfo.com
)Form 10Q is a quarterly report that gives you the same basic information as the 10K, but it details only three months’ worth of activity. Because a long time can pass between 10Ks (after all, it is a year), don’t wait 12 months to see how your company is progressing. Make a habit of seeing how the company is doing by comparing its recent 10Q with one that covers the same quarter last year. Is the profit higher or lower? How about sales? Debt?
Two types of insiders exist: those who work within a company and those outside the company who have a significant (5 percent or more) ownership of company stock. Tracking insider activity is very profitable for investors who want to follow in the footsteps of the people in the know. See Chapter 20 for information about monitoring and benefiting from insider activity.
The Value Line Investment Survey, one of many information products provided by Value Line Publishing, Inc., is considered a longtime favorite by many stock investing professionals. You can look it over at any library that has a good business reference department. In the survey, Value Line covers the largest public companies and ranks them according to financial strength and several other key business factors. To get more information about Value Line, either head to the library or visit www.valueline.com
.
Another ubiquitous and venerable publisher is Standard & Poor’s (S&P). Although it has a number of quality information products and services for both individual and institutional investors, the three you should take a look at are the following:
Check out S&P’s website at www.standardandpoors.com
for more information about its publications.
Another stalwart publisher, Moody’s offers vital research on stocks and bonds. Moody’s Handbook of Common Stocks is usually available in the reference section of a well-stocked library. It offers stock and bond guides similar to S&P and also provides an independent bond-rating service. Check out www.moodys.com
for more information.
Clint Eastwood, where are you? Traditionally, brokerage reports have been a good source of information for investors seeking informed opinions about stocks. And they still are, but in recent years some brokers have been penalized for biased reports. Brokers should never be your sole source of information. (Otherwise, Clint may ask them whether they’re feeling lucky, punks.) The following sections describe the good, the bad, and the ugly of brokerage reports.
Research departments at brokerage firms provide stock reports and make them available for their clients and investment publications. The firms’ analysts and market strategists generally prepare these reports. Good research is critical, and brokerage reports can be very valuable. What better source of guidance than full-time experts backed up by million-dollar research departments? Brokerage reports have some strong points:
During 1998–2000, an overwhelming number of brokerage reports issued glowing praise of companies that were either mediocre or dubious. Investors bought up stocks such as tech stocks and internet stocks. The sheer demand pushed up stock prices, which gave the appearance of genius to analysts’ forecasts, yet the stock prices rose essentially as a self-fulfilling prophecy. The stocks were way overvalued and were cruisin’ for a bruisin’. Analysts and investors were feeling lucky.
Investors, however, lost a ton of money (ooh, ugly). Money that people painstakingly accumulated over many years of work vanished in a matter of months as the bear market of 2000 hit (ooh, ugly). Of course, the bear market that hit in 2008–2009 was even more brutal. Retirees who had trusted the analysts saw nest eggs lose 40 to 70 percent in value (yikes, very ugly). Investors lost trillions during these major downturns, much of it needlessly. I’m sure that lots of those folks thought that they should have put that money in things that had enduring value instead — such as cookies and cases of merlot.
You don’t need to spend an excessive amount of time or money, but you should maintain your own library of resources. You may need only one shelf (or a small amount of memory on your computer’s hard drive), but why not have a few investment facts and resources at your fingertips? I maintain my own library loaded with books, magazines, newsletters, and tons of great stuff downloaded on my computer for easy search and reference. When you start your own collection, follow these tips:
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