Get that Investing Advantage Just by Learning How to Read a 10K

SEC 10K
SEC 10K

How to read a 10K

Remember the time in days past when games in personal computers were mainly text based? I sure remember playing the seminal text adventure Zork on my IBM 386 PC.

Back then, there was only text and some basic gameplay elements. Fundamental storytelling and game dynamics were the selling point of games.

Now, gamers have Call of Duty and Grand Theft Auto 5. Both of which have the selling point of big explosions, awesome graphics, and ambient lighting.

What happened to the gameplay?

Well, this is a similar debacle when reading company annual reports. The pictures and the charts are there to distract and even mislead readers in the way it is presented.

Look at this example below.

See that yellow explosion as represented by the Verna model?

That pie chart is a little sneaky because the truth is the Verna model is just ahead by a mere 31.4%. The presentation makes it look like Verna is ahead by more than 40%.

The misleading pie chart can easily sway the gullible reader who is not paying attention.

The message is clear, "The Verna model owns the other models by a mile."

Now, let's look at the figures as represented by a non-biased and ungarnished bar chart.

See the difference in the messaging?

Much like the new 3D games we have today, the pie chart is full of bling just to hide the real substance. Sometimes, there is no substance at all.

Just remember, there is no company, not even those in trouble, that will paint themselves in a bad light.

Tip #1: Colorful Charts in Annual Reports are there to Distract

Remember the time in days past when games in personal computers were mainly text based? I sure remember playing the seminal text adventure, Zork on my IBM 386 PC.

Back then, there was only text and gameplay. Fundamental storytelling and game dynamics were the selling point of games.

Now, we have Call of Duty and Grand Theft Auto 5 where the selling point are big explosions, awesome graphics, shooting brown people, and beating up women in games.

What happened to the gameplay?

Well, this is a similar debacle when reading company annual reports. The pictures and the charts are there to distract and even mislead readers in the way it is presented.

Look at this example below.

Sneaky Pie Chart
Sneaky Pie Chart

See that yellow explosion as represented by the Verna model?

That pie chart is a little sneaky because the truth is the Verna model is just ahead by a mere 31.4%. The presentation makes it look like Verna is ahead by more than 40%.

The misleading pie chart can easily sway the gullible reader who is not paying attention.

The message is clear, "The Verna model owns the other models by a mile."

Now, let's look at the figures as represented by a non-biased and ungarnished bar chart.

Data is not exaggerated
Data is not exaggerated

See the difference in the messaging?

Much like the new 3D games we have today, the pie chart is full of bling just to hide the real substance. Sometimes, there is no substance at all.

Just remember, there is no company, not even those in trouble, that will paint themselves in a bad light.

Tip #2: Can You Trust the CEO? Read the Letter to Shareholders

It is through the letter to shareholders that we get a glimpse of the real person behind a company's CEO.

As investors, we all follow the company we invest in. We know if the company is killing it or if it is in dire straits.

When reading the letter, here are some of the things you ca ask yourself:

1. Does the CEO discuss problems openly?
2. Is the CEO defensive in his writing?
3. Is the CEO too optimistic and making light of bad situations?
4. Does the CEO refer to vanity numbers to make the business look better than it really is?
5. Did the CEO deliver on what he is talking about?

The questions above were inspired by a book, Quality of Earnings, which we highly recommend.

Ask these question next time you are listening (or reading the transcript) of a conference calls.

An example of open and honest disclosure is this call by LAKE management:

We have sold some real estate assets at book value. Jesus Christ, everybody is saying we're not worth book value, but we can sell our real estate at book value. So if we can sell real estate at book value and you can collect receivables at their stated value, then you have cash. And again, you have people saying, "Well, if you're a company with $100 million of cash but no EBITDA, you're still worth nothing." That's their attitude. So what can I say? I guess we have to build up some EBITDA, and then they'll have another reason why they can't pay at the market price

The frustration in the narrative is so palpable you can feel it in the text.

But that is passion and honesty for you.

That's the thing you must look out for in the letter and call so you can determine if a company's leadership is solid.

You have been audited
You have been audited

Tip #3: Auditors Can't be Trusted

You must not trust auditors. Why? Some of them are in on the scam.

Remember Enron?

This is another awesome tip from Quality of Earnings.

While auditors need to sign off the auditing process, it is very hard to put any weight on that signature.

Auditors are being paid millions by these companies. Do you think they will blow the whistle against their benefactors? Maybe, but not likely.

In fact, I have never heard an auditor do this ever.

Tip #4: Footnotes in SEC 10K's Should be Consistent

Many investors glance over the footnotes because it is a real pain to read.

While footnotes is brimming with information, the reader should look for consistency.

Navigating the footnotes in hundred page report is like a bad dream. That is why we made a tutorial that will make it easier for you to quickly identify even the little changes made in the footnotes.

1. Open up two consecutive years of annual reports on the SEC website 2. Copy and paste the html annual report into a word processing document 3. Save the two documents 4. Use the compare feature to open up both of the documents you just created 5. You get a final document with any changes that have been made highlighted

Here is what the final product will look like.

Footnote changes

Reading the SEC 10K Doesn't Need to be a Drag

When you know how to read 10Ks properly you will be equipped with valuable and accurate data to help in your decision making.

The key to all this is to make your reading faster but without compromising accuracy in data collection.

For more investment and finance tips and tricks you can visit Old School Value, the home of the best stock analyzer software.

How to Read an Annual Report

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