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How deep do you read into your annual/quarterly reports?


InspireByReason
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I'm asking because I am a relatively new investor and it can be an incredibly overwhelming amount of information to process. Sometimes I become demotivated by it. For instance I was researching an oil company and it had recently acquired another company with a combination of common stock and preferred shares. I wanted to figure out whether or not it was a good acquisition so I went to value the company and became lost in the minutiae of understanding what was actually paid for it. Cash acquisition makes sense to me but when it comes to paying for something in shares/preferred I was stumped.

 

I've read my fair share of accounting and investing books but I still feel like a newbie when reading annual reports. Have any of you had this feeling? How did you overcome it?

 

Thanks!

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I think it's especially important to read in depth if you're new.  As you get more experienced you'll learn what to look for and I can now go through the average 10K in an hour or two finding the things I need to look for, and I really enjoy it.  But the process of getting to that point - learning what is what, and how to spot what matters - was absolutely invaluable.  Don't get demotivated. 

- If you find one too hard, try another! 

- When you get stuck on something, forget about investing in the stock and make it your goal to understand that thing.  One by one you'll master the common complexities until you start finding it easy. 

- And also remember, some of these things are deliberately done/written in a confusing way.  As a rule avoid these stocks!

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I second what was said by eclecticvalue.  Start with some smaller companies to get your feet wet with 10-Qs, 10-Ks, and S-1s.  Then work your way up to larger companies with more complex filing documents.   

 

In general, the amount of time I devote to 10-Ks and 10-Qs depends on the company, position sizing, and purpose of my research: 

-  If I am putting together a basket of similar companies (that represent a small portion of my portfolio), I may not spend much time on the 10-K and 10-Q - the basket will generally be based on a simple evaluation of balance sheet metrics or cash flow metrics.   

-  If I have a "conviction" holding (i.e. a single company that represents a meaningful % of my portfolio), then I attempt to read, front-to-back, the last 5-10 years of 10-Ks (if available) and/or the S-1. 

- If i am trying to expand my circle of competence into a new industry or niche, then I will spend some time reading, front-to-back, 10-Ks for multiple companies within the industry/niche.

 

Since you are new, it is especially important to do a lot of reading.  Pick an industry, start with small companies, and make yourself an expert by reading.  Then start to expand your circle of competence.  It is a slow process, but in the long-run, you will be a better investor. 

 

 

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I agree with cheetah but it's one of those things where you need to know what the rules are before u start bending them. Read a bunch of 10ks from a variety of companies, and sooner or later you'll realize how useful or useless they are to you.

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If I read a 10-K (often I don't), I spent like 30min on it. I sometimes spent more time, when I try to understand details that management is not talking about (pensions, asbestos liabilities, footnotes), but often it is clear by then, that if I need to dig so deep to understand the true financials, that the stock is not worth investing anyways.

 

I spent some time to read CC Transcripts in Seekingalpha. I like to compare what industry leaders/ good managers say, compared to what the management of the company I am interested states. I found some of the best tidbits in competitors CC or presentations.

 

I agree with others that it is important to understand what drives and industry, what metrics to look for and to distinguish between  spin and facts.

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I'm asking because I am a relatively new investor and it can be an incredibly overwhelming amount of information to process. Sometimes I become demotivated by it. For instance I was researching an oil company and it had recently acquired another company with a combination of common stock and preferred shares. I wanted to figure out whether or not it was a good acquisition so I went to value the company and became lost in the minutiae of understanding what was actually paid for it. Cash acquisition makes sense to me but when it comes to paying for something in shares/preferred I was stumped.

 

I've read my fair share of accounting and investing books but I still feel like a newbie when reading annual reports. Have any of you had this feeling? How did you overcome it?

 

Thanks!

 

You overcome it by realizing the guys who own or are short the stock have read everything about the company including all the annuals/Q reports.  You must assume they are several steps ahead of you and if you cut corners before making a concentrated bet you are the patsy and you will lose your money. 

 

Fear of losing your savings and respect for the market should motivate you. 

 

 

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I appreciate the suggestions guys  :) I think i'll start out by taking a closer look at some of these small companies.

 

I just read the business summary and risk factors. If I'm unmotivated by that point, I just move on. No point investing in something that's not motivating.

 

 

I appreciate the notion of vetting further research. One thing that really stuck out in Poor Charlie's Almanack was the idea of 3 piles. Yes No and Too Hard. The faster I can vet out the ones I'm sure I wouldn't understand the more likely I'm to find something good.

 

I am not sure reading 10k or 10q is the best use of your time. I think it's more important to understand a variety of business models and what drives their earnings. Small details are generally distractions

 

Cheetah you suggest understanding business models but how do you actually go about researching to understand different models? I have yet to find a platform or book that talks about business models. Also on this point, why is this more important than looking at value or what is the difference?

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Remember this, stock prices rarely go up if earnings is not getting better, so it is very possible to lose your shirt even when you think a company is very unvalued. Go read business history books - study the up and down of important companies from the past e.g. Xerox, IBM, RCA Walmart etc See if you can figure out repeating patterns between their stock prices and their changing fundamentals. If you want all the answers right away, I have an amazing deal - for $10k, I will tutor you for 2 days ;)

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I'm surprised no one on this board mentioned reading the Letter to the Shareholders in the Annual Report (not in the 10-K). Especially for companies I don't own, it's a very quick way to get a feel of what is important to the company, especially in regards to new projects, which are hard to fit into 10-Ks and Qs. Unfortunately, you need to read 10-Ks and Qs fairly deeply, ESPECIALLY for small companies. NM, to name one example, filed a 20-F (the equivalent of a 10-K for a foreign issuer) on April 25 that said, on page 41, that Vale would not be performing on a contract for an iron ore port facility that NM was building. The bonds fell from 76 to 60 on the news. I, for one, would have liked a press release and a trading halt when they first learned the news.

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I'm surprised no one on this board mentioned reading the Letter to the Shareholders in the Annual Report (not in the 10-K). Especially for companies I don't own, it's a very quick way to get a feel of what is important to the company, especially in regards to new projects, which are hard to fit into 10-Ks and Qs.

I agree that the letter to shareholders is important.

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Cheetah you suggest understanding business models but how do you actually go about researching to understand different models? I have yet to find a platform or book that talks about business models. Also on this point, why is this more important than looking at value or what is the difference?

Understanding the business model is absolutely critical for valuation.  A 10 PE or EV/EBIT  is means different things to a See's type company (good margins, low cap requirements, seasonal, limited growth prospects) versus a Google/Alphabet circa 2000 (good margins, ample investment opportunity, great growth requiring capital) versus GM or a mining company.

 

All this is about is increasing your circle of competence. Reading AR without understanding, including understanding the business model is better than useless, but not very productive. If you are in business or work in a business, look at that business first.  Read the trade magazines.  Do a one page Michael Porter analysis of the company or industry.  Look at business school case studies of the industry.

 

Once you have the background, call people in the industry, competitors and suppliers. Ask them what are the key drivers in the industry, then see if you can figure out what financial data is most relevant.  Don't be discouraged you have an exciting lifetime of learning ahead.

 

 

Personally, I do not read broker reports, but once you have done the above, one question you can ask industry participants is who is the best Wall Street analyst. (Remember they may only mention those who have looked at their company favorably.) With that info, look at any relevant industry report, with the second caveat that analysts create business for investment bankers and their orientation is short term.  By the way, looking at old reports and predictions is humbling and informative, for many, if not all businesses, (this despite the furious technological changes).

 

 

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Cheetah you suggest understanding business models but how do you actually go about researching to understand different models? I have yet to find a platform or book that talks about business models. Also on this point, why is this more important than looking at value or what is the difference?

Understanding the business model is absolutely critical for valuation.  A 10 PE or EV/EBIT  is means different things to a See's type company (good margins, low cap requirements, seasonal, limited growth prospects) versus a Google/Alphabet circa 2000 (good margins, ample investment opportunity, great growth requiring capital) versus GM or a mining company.

 

All this is about is increasing your circle of competence. Reading AR without understanding, including understanding the business model is better than useless, but not very productive. If you are in business or work in a business, look at that business first.  Read the trade magazines.  Do a one page Michael Porter analysis of the company or industry.  Look at business school case studies of the industry.

 

Once you have the background, call people in the industry, competitors and suppliers. Ask them what are the key drivers in the industry, then see if you can figure out what financial data is most relevant.  Don't be discouraged you have an exciting lifetime of learning ahead.

 

 

Personally, I do not read broker reports, but once you have done the above, one question you can ask industry participants is who is the best Wall Street analyst. (Remember they may only mention those who have looked at their company favorably.) With that info, look at any relevant industry report, with the second caveat that analysts create business for investment bankers and their orientation is short term.  By the way, for many business, despite the furious technological changes, looking at old reports and predictions is humbling and informative.

 

 

 

Thank you for your answer. Are there any websites or books that you would recommend that explains things like "key drivers" and financial data?

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Thank you for your answer. Are there any websites or books that you would recommend that explains things like "key drivers" and financial data?

 

To answer a different question, a good book to understand business models is "The Little Book that Builds Wealth" or "The Five Rules for Successful Stock Investing" both by Pat Dorsey.

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I think its pointless to read the annual report of most companies unless you have a good reason to. I predict that you will retain nothing and it will be an exercise in boredom.

 

My view is that reading things like annual reports should be driven by the desire to find out something specific. Otherwise you are just wasting your time. I would first find a company you are interested in. And you do that by first discarding a lot of companies you aren't interested in. Then once you find it, you can try to figure out how it makes money. And if it gets too complicated I would just throw it on the too hard pile and move on. You should only read the annual report in order to answer a question you have about the company.

 

And if you want to understand business models the single best way is to become really good at doing Fermi problems. I usually first do the Fermi problem in my head without knowing anything about the business. I used to do the same with ValueLine. I would read a value line on some company and just after reading its description I would try to guess its revenue, number of employees, earnings and market cap. Then I would look at the valueline data and see if I was right. Or sometimes I would just look at valueline data directly and try to guess the companies price. This is a much more active way of analyzing a company, its much less boring and you will learn a lot especially when your guesses are wrong!

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