When investing in public companies, it’s almost impossible to have too much data. One of the richest sources of information about the operations of public companies is the reporting they must file by law — specifically, their annual report, 10-K report and 10-Q report.
If you plan to buy the stock of a public company, it is critical that you first obtain these reports and know how to cull the information within them. This is especially true if you do stock picking on your own, though it is also helpful if you rely on the advice of a broker or financial planner in deciding which stocks to buy and sell.
Three Separate Reports
The SEC requires all companies owned by the public to file an annual report, 10-K and 10-Q. Here is a brief overview of each:
- Annual report — This is probably the best known of the three reports. Public companies create annual reports primarily to showcase the business to investors in the best possible light while remaining within the strict confines of SEC regulations.
- 10-K report — This is the official report that is filed annually by public companies with the SEC. It is usually longer and more detailed than the annual report, but does not contain glossy pages, color photographs or a letter from the Chairman or CEO.
- 10-Q report — This is similar to the 10-K report but it is filed with the SEC on a quarterly instead of annual basis. A 10-Q contains less detailed information than a 10-K — its primary purpose is to compare the two most recent quarters’ financial performance, and the financial performance of the most recent quarter to the same quarter a year ago. In addition, the financial statements are generally unaudited.
In terms of importance to an investor, the 10-K report probably ranks at the top. It offers a bare-knuckle, no-frills, no-spin look at every aspect of the operations of a public company. There are no fancy charts or diagrams, pretty pictures or fluffy Chairman’s letter — it’s “just the facts” in black and white.
For this reason, average investors are sometimes intimidated by 10-K reports and instead gravitate toward the easier-to-read annual report. Reading the annual report is certainly better than not reading any report, but if you want the most detailed and unadulterated information about a company before investing, you need to dig into the 10-K.
What is in the 10-K Report?
A typical 10-K consists of the following sections:
- Business overview — Describes the company’s operations from a big-picture perspective.
- Risk factors — Explains the primary risks to the business’ success.
- Legal proceedings — Details any pending lawsuits against the company or other legal matters it’s facing.
- Selected financial data — This is the real “meat and potatoes” of the report that contains all of the detailed financial information, including the balance sheet, cash flow statement, profit and loss statement, budget and financial forecasts, to name a few.
- Management discussion and analysis (MD&A) — Here, you can read the company’s take on various aspects of the business — potentially everything ranging from the finances and sales and marketing to how they plan to address specific risks and grow the company.
How to Read Company Reports
It is often a good idea to start your research into a public company by reading its annual report. These are usually written in investor-friendly language and contain easy-to-understand charts and graphs so average investors can grasp the most important concepts with regard to investing in the company. They also usually contain more detailed charts and information in the back if you want to dig in deeper.
After you have read the annual report to get a good overall feel for the company, you’re ready to dive into the 10-K. Start at the beginning with the business description to make sure you completely understand exactly what it is that the company does. Then skip to the financial section and the MD&A to familiarize yourself with the company’s current financial condition and future growth prospects.
Look especially closely at the balance sheet, cash flow statement and income statement. Is the balance sheet strengthening or weakening over time? How strong is cash flow in relation to net income? Fast-growth companies sometimes report solid sales growth but poor cash flow as cash is being siphoned off to support the growth. This can only go on for so long before a company faces the prospect of bankruptcy.
Now go back to the sections discussing risk factors and legal proceedings. Every company faces some kind of risk, so you should not necessarily view every risk as a major red flag. Look especially closely at any risk factors that appear unusual or that could be especially crippling to a company. For example, Target’s 10-K lists “significant data security breach” as a risk factor — in hindsight, this is something Target investors should have seriously considered before buying the company’s stock.
The same thing holds true when it comes to legal proceedings. While pending lawsuits or other types of legal matters should not be ignored, they should be looked at in the proper perspective. A pending $10 million lawsuit against a billion dollar company is not necessarily a cause for concern. In some industries like pharmaceuticals, lawsuits and drug liability claims are common — even suits with claims in the hundreds of millions of dollars. Look at how much cash the company has on the balance sheet to cover any potential claims that might be rendered against it.
Obtaining Company Reports
It’s easy to obtain a copy of a public company’s annual report. Just visit the company’s website and look for the Investor Relations link. From here, you can usually download an electronic copy of the annual report, or find a phone number for Investor Relations to request that a hard copy be mailed to you.
Obtaining a copy of the 10-K or 10-Q can seem, a bit more challenging, but is also quite doable. Public companies file these reports to the SEC using a system called the Electronic Data Gathering, Analysis and Retrieval system, or EDGAR for short. There are several different search tools on EDGAR you can use to look for the reports you need.
Another great resource for learning more about how to research public companies is www.360financialliteracy.org. This site is maintained by the American Institute of Certified Public Accountants (AICPA) — which is the governing body of the US accounting industry.
While annual reports, 10-Ks and 10-Qs will never be mistaken for the latest scintillating best-selling novel, they are essential tools for anyone who wants to invest in public companies. You should take the time to learn what is in these reports and the best way to read them before buying the stock of any public company.