Portfolio manager Geoffrey Abbott, profiled recently in the Wall Street Journal, has an old-school strategy for finding new investment ideas: he’s reading thousands of the annual reports and corporate letters of the nation’s largest companies.
Abbott’s decision to hit the books may sound decidedly antiquarian. But there’s a lesson in Abbott’s strategy: with a little commitment, you can still learn a lot by reading.
Why read annual reports, financial statements and other corporate filings? If you’re thinking about investing in a company, they can tell you much about the company’s long-term prospects.
Printed copies of a corporation’s typical annual reports are handsomely bound booklets, on heavy stock paper, with high-end photography and professional graphic design. A lot of effort goes into making these reports as attractive as possible, since they’re intended in part to attract new investors and bolster the confidence of current investors.
But for a fuller understanding of a company’s position, let’s look at a separate but related annual report-the company’s 10-K filing with the Securities and Exchange Commission (SEC). These legally mandated annual filings include greater substance and detail about a company’s performance and potential.
A word of warning: 10-K reports aren’t necessarily easy reading. But if you understand the basic structure of the report and learn how to read its elements, you can learn a lot about a company. And while you don’t have to be a certified public accountant to get the benefits of reading a company’s annual report, some familiarity with financial terminology and a basic understanding of what various financial statements mean, will certainly help – more on that below.
A few suggestions to get started:
- The SEC’s EDGAR database is a powerful tool for searching company filings. Type the company name you are interested in into EDGAR and you’ll quickly have a list of their filings. In the left-hand column, find and select “10-K.” (Check out the SEC’s online guide to using EDGARaimed at investors for more on this useful tool).
- If you’re new to corporate filings, one approach is just to dig in. Pull up the 10-K report of a company that interests you and browse through its key components to grasp the overall structure.
- Read through the initial section titled “Business,” in which the company describes its mission and operations in broad terms. Does the description square with what you know about the company? Does it raise other questions or concerns?
- Another particular area of interest is the “Risk Factors” section, in which the company details potential occurrences that could affect operations or revenues, like regulatory threats, consumer preference shifts, economic shocks and other disruptive factors. Similarly, the “Legal Proceedings” section may alert you to any pending legal actions against the company that you should know about. But keep in mind that the factors a company identifies aren’t necessarily the only ones out there.
- The section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (MD&A) details the company’s operations and financial condition. This section is designed to give you a grasp of the company’s business plan and performance.
- To get the most out of the MD&A and the financial statements that follow will require more in-depth knowledge about reading and comparing financial data. If you want to learn more about reading financial statements, there are a great many options online. This Merrill Lynch guide to reading financial reports is a good place to start.
Spending even a little time learning to understand company filings will empower you as an investor. You won’t be basing your investment decision solely on subjective factors like whether you “like” the company, use its products or saw a glowing report in the financial media.
Likewise, even if you’re working with a broker, financial advisor or other professional, you should take time to look through the filings and learn about the company in more detail. And before investing in any company, you should read the company’s prospectus carefully. After all, it’s your money you’re investing.
A caveat: The limitations of financial reports
Spending time looking through published corporate materials like 10-K reports, CEOs’ letters to investors and other filings also helps bolster your understanding and appreciation of how much work goes into running an enterprise of any kind.
But recognize that a company’s financial report will not give you the entire picture. There are a number of facts to be considered that generally are not contained in the financial reports – such as economics of the country and the particular industry, the management of the company, and the company’s plans for the future.
Still, for a deeper understanding of how business works, a good place to start is developing basic skills in knowing what to look for in a financial report. And the more of them you read, the more you’ll learn. So roll up your sleeves and get reading.
Want to learn more about how to read and think like an investor? Here are a few more resources to move beyond annual reports:
How to read a financial report
Merrill Lynch’s 47-page “How to Read a Financial Report” guide is an excellent primer on reading balance sheets, income statements and other financial filings, and includes an extensive glossary of key terms.
The art of the corporate letter
Portfolio manager Geoffrey Abbott notes that not all letters are created equal. Here’s the list of his 16 favorite CEO letters of 2015, based upon those that he saw as the most transparent and useful for investors.
Warren Buffett’s favorite reads
Famed investor Warren Buffett of Berkshire Hathaway is known for his detailed yet readable annual letters, which explain the company’s ups and downs with a healthy dose of folksy wit and wisdom. But Buffett is also a voracious and careful reader. In 2015 he shared a list of his favorite books on business and investing with the WSJ.