Quarter Looks
Reading Quarterly and Annual Reports (Part Two)
After a very substantive introduction, the quarterly or annual report continues with so much information, it can be more than overwhelming. In fact, it’s designed to be indecipherable by the average human for a specific reason, Wall Street wants more of your money. Yes, everything you ever wanted to know in the spirit of full transparency is readily available, but you’ll need to be trained in financial and managerial accounting to understand it. You’ll also need to have a wealth of experience with these reports in a specific industry to really be able to delve in and read between the lines.
So what is the average investor to do with quarterly and annual reports, especially given the time restraints of pouring through reports of many different companies in different industries. Well, we need to figure out what parts of the report we can trust to the expert analysts, and which parts we need to form our own conclusions from.
Quarterly and annual reports are organized into Parts and items. We’ll be using quarterly reports as an example for the rest of this article, so please note that Annual reports have a few more parts and items. Part 1 is financial information, and part 2 is generally other information. Within part 1, there are several items. Item 1, financial statements is the meat of the filing, but not necessarily where we want to look first. The Income Statement, Balance Sheet and Statements of Cash-flow along with notes are chopped up, standardized, organized and analyzed ad nauseam. The results are available to investors in the form of real time, easily comparable valuation measurements and key statistics. Additionally, we can see the opinions of analysts on what these valuations will look like in the future, also stacked and categorized for your convenience. So although very important, item 1 is not where we are going to find any market inefficiencies.
Lets scroll down a bit to item 2, Managements Discussion and Analysis of Financial Condition and Results of Operations (Item 7 on Annual reports). Before we start reading, however, note how far you had to scroll down, and how big the company is you are researching. Notes to the financial statements should be comparable to the size of the company. Bigger companies will inevitably have a ton of different financing, options, preferred shares, recent acquisitions or mergers, judgments, tax issues and the list goes on and on. A smaller company generally shouldn’t have as much going on, and if your finger got tired from scrolling, the company may be highly leveraged, or more interested in selling shares than their product/service.
Managements Discussion and Analysis of Financial Condition and Results of Operations leads to a deeper understanding of the financial statements. In fact, after reading one, you will probably look at the financial statements and valuations for that company, as well as any other stock in that industry, in a very different light. For example, you may find out that the company experiences higher revenues during a certain time of the year, or that expenses go up due to seasonal commodity price swings.
You’ll also be able to see a breakdown of where all the revenues come from, how much is from how many different customers, how much is foreign or domestic, what the different growth rates and margins are, and similar breakdowns of expenses, research and development and more. These figures are essential when trying to make comparisons to competitors.
What Item 2 also does is tell the story of the company in plain language. Why were our revenues higher but our earnings were lower. Where was/wasn’t the demand. Did we meet the demand or fall short. Did we gain/loss market share. All of these questions are addressed, if applicable, and the larger the company, the more we’ll get.
Don’t assume that spin doesn’t exist in these reports. The smaller the company or newer the industry, the more opportunities there will be for spin. Generally, however, the spin has already been standardized by each industry, and has been in place for so long, the way they break everything down cannot be changed from quarter to quarter. In fact, this part of the quarterly or annual report can take a press release and give it a strong dose of Sodium Pentothal.
In part three, we’ll take a look at the risk disclosure and discover why it’s a little bit different than your standard fine print. We’ll also discuss how to learn a lot about whats in a filing simply based on the timing of it.
About the Author
Daniel Long founded Penny Stocks Weekly in 2003 as an unbiased alternative for Small and Micro Cap stock research, analysis and opinion. Join our free weekly newsletter, subscribe to our premium service, or just browse all of our latest articles: http://www.pennystocksweekly.com
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