Solving the 10-K Puzzle

Ask any fund manager about 10-K filings and they’ll likely smile and tell you that they are a vital tool for investors. Even Warren Buffet has said that he loves to curl up with the reports. Let’s take a closer look at the 10-K filing and the secrets that it holds.

What is a 10-K?

The United States Securities and Exchange Commission requires all publicly traded (and some privately traded) companies to file an annual report, known as a 10-K. Sometimes, investors also call the 10-K the annual report. Annual reports are available to view for free from the SEC website.

The 10-K filing isn’t the same as the annual report to shareholders, the information contained differs slightly, whereas the 10-K filing has specific parts that are the same for similar filers. The 10-K has 4 parts and 15 schedules.

Part 1 – The Overview

The first part of the filing addresses the business of the company, there’s a description of what the company does, what it owns and what market it operates in. This is the place to read about recent changes to the company, new competitors, and any labor issues that it may be dealing with. This part of the filing also addresses any legal proceedings that are pending or that will affect the company in the future. Finally, part one covers any properties or physical assets that are owned by the company, intellectual properties aren’t included here, they’re addressed later in the report.

Part 2 – The Details

The second part of the 10-K is the meat of the filing. It gives the highs and lows of the stock, in a simple, easy to understand the statement. What’s more, the financial statements are included in this section. Financial statements include the balance sheets and notes about any accounting practices of note.

There are a lot of things to look at here, but balance sheets are quite telling. This allows investors to get an understanding of how much cash a company has on hand, and what kind of revenue it’s bringing in. Huge changes from year to year can be a good, or a bad thing, and indicate change within a company that’s worth investigating. Finally, while there are reasons to do so, a change in auditors is often a red flag.

Part 3 – The Management

The third part of the filing is all about the management. It lists the Directors, Executive Officers, and the corporate governance. It also lists the executive compensation. It’s good to take a look at the compensation in relation to the balance sheet and also in relation to the company goals. A company that incentivizes its management based on growth is more likely to see that growth realized.

The bottom line here is people simply perform better when there is a reward involved. It’s also important to take a look at the executive perks, and “certain relationships.” Taking a look at certain relationships, investors can see if the company has any obvious conflicts, such as choosing the CEO’s relative as a supplier.

Part 4 – Final Details

This section of the 10-K includes some of the most important details in the entire filing. The financial statements here include detailed breakdowns of what certain items, and legal company documents such as company bylaws and copies of material contracts.

Practice, practice, practice

It takes practice to become familiar with 10-K filings and how to read them. That’s why it’s important to begin practicing immediately. Individuals interested in investing in a specific company should read through several years of 10-K filings, and become familiar with the goals set forth, did the company reach those goals? If not, was there a legitimate reason that the company fell short? Is there an indication the company will perform well in the future? It’s all right there in the 10-K.