Stock Investing For Dummies, 5th Edition - Paul Mladjenovic (2016)

Part III. Picking Winners

Chapter 12. Decoding Company Documents


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.

remember If you plan to hold a stock for the long haul, reading the annual report and other reports covered in this chapter will be very helpful. If you intend to get rid of the stock soon or plan to hold it only for the short term, reading these reports diligently isn’t that important.

A Message from the Bigwigs: Reading the Annual Report

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.

tip The following resources also provide access to annual reports:

·        Check out the Public Register’s Annual Report Service. Go to to order a hard copy or to to view reports online. This organization maintains an extensive collection of annual reports.

·        Use the free annual report service of The Wall Street Journal. If you read this newspaper’s financial pages and see a company with the club symbol (like the one you see on a playing card), then you can order that company’s annual report by calling 800-654-2582 or visiting the website (

You need to carefully analyze an annual report to find out the following:

·        How well the company is doing: Are earnings higher, lower, or the same as the year before? How are sales doing? You can find these numbers clearly presented in the annual report’s financial section.

·        Whether the company is making more money than it’s spending: How does the balance sheet look? Are assets higher or lower than the year before? Is debt growing, shrinking, or about the same as the year before? For more details on balance sheets, see Chapter 11.

·        What management’s strategic plan is for the coming year: How will management build on the company’s success? This plan is usually covered in the beginning of the annual report — frequently in the letter from the chairman of the board.

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 on to the stock. I describe the makeup of the annual report and proxy materials in the following sections.

Analyzing the annual report’s anatomy

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 letter from the chairman of the board

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.

remember To get a good idea of what issues the company’s management team feels are important and what goals it wants to accomplish, keep the following questions in mind:

·        What does the letter say about changing conditions in the company’s business? How about in the industry?

·        If any difficulties exist, does the letter communicate a clear and logical action plan (cutting costs, closing money-losing plants, and so on) to get the company back on a positive track?

·        What’s being highlighted and why? For example, is the firm focusing on research and development for new products or on a new deal with China?

·        Does the letter offer apologies for anything the company did? If, for example, it fell short of sales expectations, does the letter offer a reason for the shortcoming?

·        Did the company make (or will it make) new acquisitions or major developments (say, selling products to China or a new marketing agreement with a Fortune 500 company)?

tip Read an annual report (or any messages from upper management) in the same way you read or hear anything from a politician — be more concerned with means than ends. In other words, don’t tell me what the goal is (greater profitability or peace on earth); tell me how you’re going to get there. Executives may say “we will increase sales and profits,” but saying “we will increase sales and profits by doing X, Y, and Z” is a better message because you can then decide for yourself whether the road map makes sense.

The company’s offerings

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:

·        How does the company distribute its offerings? Through a website, malls, representatives, or some other means? Does it sell only to the U.S. market or is its distribution international? Generally, the greater the distribution, the greater the potential sales and, ultimately, the higher the stock price.

·        Are most of the company’s sales to a definable marketplace? For example, if most of the sales are to a war-torn or politically unstable country, you should worry. If the company’s customers aren’t doing well, that has a direct impact on the company and, eventually, its stock.

·        How are sales doing versus market standards? In other words, is the company doing better than the industry average? Is it a market leader in what it offers? The firm should be doing better than (or as well as) its peers in the industry. If the company is falling behind its competitors, that doesn’t bode well for the stock in the long run.

·        Does the report include information on the company’s competitors and related matters? You should know who the company’s competitors are because they have a direct effect on the company’s success. If customers are choosing the competitor over your firm, the slumping sales and earnings will ultimately hurt the stock’s price.

Financial statements

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 result (net income or net loss).

Next, look at the balance sheet. It provides a snapshot of a point in time (annual reports usually provide a year-end balance sheet) 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.

warning Carefully read the footnotes to the financial statements. Sometimes big changes are communicated in small print. In current times, especially be wary of small print pointing out other debt or derivatives. Derivatives are complicated and (lately) very risky vehicles. Problems with derivatives were one of the major causes of the market turmoil that destroyed financial firms on Wall Street during late 2008. AIG, for example, is a major insurer that had to be bailed out by the Federal Reserve before it went bankrupt (shareholders suffered huge losses).

warning Derivatives are a huge land mine, and large money center banks still carry them. According to the Bank for International Settlements (, major money center banks are carrying more than 1 quadrillion dollars’ worth of derivatives. (Whew! Now I see why they give away so many toasters.) Derivatives are especially worth being aware of if you’re considering bank or other financial stocks for your portfolio.

Summary of past financial figures

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.

Management issues

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?

CPA opinion letter

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.

tip The CPA opinion letter offers an opinion about the accuracy of the financial data presented and information on how the statements were prepared. Check to see whether the letter includes any footnotes regarding changes in certain numbers or how they were reported. For example, a company that wants to report higher earnings may use a conservative method of measuring depreciation rather than a more aggressive approach. In any case, you should verify the numbers by looking at the company’s 10K document filed with the Securities and Exchange Commission (SEC; I describe this document in more detail later in this chapter).

Company identity data

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.

Stock data

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.

Going through the proxy materials

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. 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.

Dig Deeper: Getting a Second Opinion

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.

tip The information and research they provide can be expensive if you buy or subscribe on your own, but fortunately, most of the resources mentioned are usually available in the business reference section of a well-stocked public library.

Company documents filed with the SEC

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:

·        Drop by the company itself. Stockholder services departments keep these publicly available documents on hand and usually give them out at no cost to interested parties.

·        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.

tip At the SEC’s website (, you can check out EDGAR (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.

Form 10K

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.

tip The following websites can help you make sense of 10K reports:

· (

·        SEC Info (

· (

Form 10Q

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?

remember Keep in mind that not every company has the same fiscal year. A company with a calendar year fiscal year (ending December 31) files a 10Q for each of the first three quarters and files a 10K for the final quarter. The company reports its fourth quarter data in the 10K, along with the statistics for the full year.

Insider reports

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.

remember Every time an insider (such as the CEO or controller) buys or sells stock, the transaction has to be reported to the SEC. The insider actually reports the trade prior to transacting it. These reports are publicly available documents that allow you to see what the insiders are actually doing. Hearing what they say in public is one thing, but seeing what they’re actually doing with their stock transactions is more important.

Value Line

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

Standard & Poor’s

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:

·        S&P Stock Reports: Available at many libraries, this guide comes out periodically and reports on stocks on the New York Stock Exchange and the largest firms listed on Nasdaq. It gives a succinct, two-page summary of each stock, offering a snapshot of the company’s current finances, along with a brief history and commentary on the company’s activities. This guide also rates companies based on their financial strength.

·        The S&P Industry Survey: S&P gives detailed reports on the top industries, cramming a lot of information about a given industry in four to seven pages. This annual publication provides a nice summary of what’s happened in each industry in the past 12 months, what the industry looks like today, and what the prospects are for the coming year. It also provides the important numbers (earnings, sales, and industry ranking) for the top 50 to 100 firms in each industry.

·        S&P Bond Reports: Yes, I know this book is about stocks. But a company’s bond rating is invaluable for stock investors. S&P analyzes the strength of the bond issuer and ranks the bond for creditworthiness. If S&P gives a company a high rating, you have added assurance that the company is financially strong. You want the company to have a bond rating of AAA, AA, or A, because these ratings tell you that the company is “investment-grade.”

Check out S&P’s website at for more information about its publications.

Moody’s Investment Service

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 for more information.

tip A stock rated highly by both Moody’s and S&P is a great choice for investors hunting for value investments.

Brokerage reports: The good, the bad, and the ugly

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 lucky punks.) The following sections describe the good, the bad, and the ugly of brokerage reports.

The good

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:

·        The analysts are professionals who should understand the value of a company and its stock. They analyze and compare company data every day.

·        Analysts have at their disposal tremendous information and historical data that they can sift through to make informed decisions.

·        If you have an account with the firm, you can usually access the information at no cost.

The bad

warning Well, brokerage reports may not be bad in every case, but at their worst, they’re quite bad. Brokers make their money from commissions and investment banking fees (nothing bad here). However, they can find themselves in the awkward position of issuing brokerage reports on companies that are (or could be) customers of the brokerage firm that employs them (hmmm — could be bad). Frequently, this relationship results in a brokerage report that paints an overly positive picture of a company that can be a bad investment (yup, that’s bad).

The ugly

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 equally 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.

remember During that bear market of 2000–2002, a record number of lawsuits and complaints were filed against brokerage firms. Wall Street and Main Street learned some tough lessons. Regarding research reports from brokerage firms, the following points can help you avoid getting a bad case of the uglies:

·        Always ask yourself, “Is the provider of the report a biased source?” In other words, is the broker getting business in any way from the company she’s recommending?

·        Never, never, never rely on just one source of information, especially if it’s the same source that’s selling you the stock or other investment.

·        Do your research first before you rely on a brokerage report. Check out annual reports and the other documents I recommend earlier in this chapter.

·        Do your due diligence before you buy stocks anyway. Look at Parts 1 and 2 to understand your need for diversification, risk tolerance, and so on.

·        Verify the information provided to you with a trip to the library or websites (see Appendix A).

tip Although I generally don’t rely on Wall Street brokerage analysts, I do track some independent investment analysts. I mention some of my favorites in Appendix A.

Do It Yourself: Compiling Your Own Research Department

You don’t need to spend an excessive amount of time or money, but you should maintain your own library of resources. You may only need 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:

·        Keep some select newspapers. Barron’s, The Wall Street Journal, and Investor’s Business Daily regularly have some editions that are worth keeping. For example, The Wall Street Journal and Investor’s Business Daily usually publish a year-in-review issue the first business week in January. Barron’s has special issues reviewing brokers and financial websites.

·        Subscribe to financial magazines. Publications such as Forbes and Money magazines offer great research and regularly review stocks, brokers, and resources for investors.

·        Keep annual reports. Regarding the stocks that are the core holdings in your portfolio, keep all the annual reports (at the very least, the most recent three).

·        Go to the library’s business reference section periodically to stay updated. Hey, you pay the taxes that maintain the public library — you may as well use it to stay informed.

·        Use the Internet for research. The web offers plenty of great sites to peruse; I list some of the best in Appendix A.

tip Financial reports are very important and easier to read than most people think. An investor can easily avoid a bad investment by simply noticing the data in what seems like a jumble of numbers. Figure out how to read them. For a great book to help you with reading financial reports (without needless technicality), check out How to Read a Financial Report: Wringing Vital Signs Out of the Numbers, 8th edition, by John A. Tracy, or the latest edition of Fundamental Analysis For Dummies, by Matt Krantz (both published by Wiley).