How to Read Company Financial Reports

National Press Foundation Paul Miller Fellows September 2013

Overview
Understand SEC 10-Ks, 10-Qs, 8-Ks, S4s, 13D Decipher CEO pay packages by looking at proxy statements or Form 990s. Learn from SEC filings about company strategies, markets, competition risks and legal liabilities. Feed ratios, KPIs, analyst comment into coverage; spot and enterprise. Awareness of the political economy around financial reporting.

Public vs. Private

Public companies issue stock to investors, traded on public exchanges Private companies do not (some issue public bonds, or limited stock.) Non-Profit Orgs file IRS Form 990, a public financial statement

Balance Sheet Assets = Liabilities + Equity Equity = Assets - Liabilities The T balances Maximizing shareholder equity

Income Statement Revenues Expenses = Income Income = Revenue Expenses Income = Profit (Loss)

Accounting
GAAP - Generally Accepted Accounting Principles Private Sector Standard Setting Bodies authorized by the SEC FASB Financial Accounting Standards Board, Norwalk, Conn. (US GAAP) IASB International Accounting Standards Board, London, UK. (IFRS, 120 countries)

Accrual vs. Cash

Debits and Credits Advance recognition of revenue to match economic activity Revenue does not equal cash
Sales on credit

What are revenue recognition rules?

Cash Flow Statement

Accrual method means income statement, revenue, sales and expense dont equal cash flow Cash flow statement provides a picture of where the real money goes in and out Starts with net income and backs out noncash items How does the company use its cash? Compare that to managements strategy?

Brief History Lesson Why this boring dry financial stuff matters Understanding the big picture The publics legal rights to information

Legal Framework
Crash of 1929, Congress holds hearings Securities Act of 1933 - creates SEC Securities Exchange Act of 1934 regulates stock markets, protects investors CFR Title 17 - Stock issuing companies are required to register with the SEC and file periodic public reports

1980s S&L Crisis

1000s of S&Ls and banks fail due to hot money real estate lending, ponzi schemes Jim Wright, Keating Five FIRREA Financial Institutions Reform, Recovery and Enforcement Act of 1989, banned goodwill from bank capital, triggered ware of federal takeovers 1990s Commercial Bank Credit Crunch

Federal Law Requires Fair Disclosure

SEC issues Reg FD in 2000 to eliminate selective disclosure of market moving info Requires publicly traded companies to disclose material information to all investors at the same time Company conference calls with financial analysts are open; anyone can dial-in.

All Lawyered Up
SEC Rule 10b-5 prohibits material misstatements and fraud 1988 Supreme Court allows shareholder classaction lawsuits, fraud on the market theory 1995 Private Securities Litigation Reform Act raises bar for filing shareholder suits Stoneridge Investment Partners LLC vs. Scientific-Atlanta, 2008 Sup Ct.

2000s Accounting Scandals

Dot.com bust, Enron, Worldcom, et al. Big five auditor Arthur Anderson indicted Sarbanes-Oxley Act tightens corporate governance, requires companies to set up internal controls SOX establishes PCAOB

Financial Crisis of 2007-2008

U.S. Housing bubble bursts, causing value of mortgage backed securities to plummet. Massive losses on assets damaged bank capital. Worst Financial Crisis since the Great Depression. Global financial system near collapse amid liquidity crunch. Bear Stearns, Lehman Brothers 2010 Dodd-Frank Act mandates study of FV, etc.

Business Reporting
Use company financial statements in your reporting Ask better questions, probe the right subjects, establish credibility Always read the statements first, press release second. Watch the spin.

10-Ks and 10-Qs

Annual Report, 10-K, is audited; Quarterly Report, 10-Q, is not Management Discussion and Analysis Litigation Certain Transactions Related Party Transactions Read and Assess Footnotes Auditors letter. Clean?

Proxy Statement
SEC Form 14-A, Notice of Annual Meeting How much CEO and senior mgmt are paid Any side deals between management and the company Who the board members are Questions shareholders will vote on

8-K, Report of Material Event

Must be filed to inform investors of major developments. Mergers and acquisitions, major sale of assets, lawsuits, regulatory penalties Generally, by definition this is news; sometimes the PR people spin, or stay silent. Look for what investor relations people are telling the markets.

IPO, or Initial Public Offering

S-1, or Prospectus Companies that go public or sell stock to investors through a public offering must first file a Registration Statement (S1) with Exhibits to the SEC Facebook; Sold at $38, dropped to $20 in two months Revenue model issue.

Who owns the stock?

Insiders are believed to know more about their company than anyone else; Form 144, or Form 4 issued when insiders buy or sell shares. Is CFO dumping shares? Form 13-D shows buyers of 5 percent or more of outstanding shares. Activist investors, controlling shareholders. Investment funds

Ratios, KPIs, and Warren Buffett

ROE = Return on Equity ROA = Return on Investment Expensive or cheap? Book Value vs Price, or Price to Book = Trading at X times book value Compare to Industry Benchmarks Lehman and Repo 105, leverage ratios, offbalance sheet vehicles

How To Use Wall Street Research

Listen to the CEO/CFO earnings calls with analysts. Follow the jargon; are the analysts focused on particular ratios or dynamics in the reports? Get analyst reports and phone numbers; Develop source relationships. Institutional investors Consolidation vs business unit results

Assert Skepticism & Judgment

Just because info is in a companys SEC report, doesnt necessarily mean its true! Ask yourself whats real? Wheres the air?? Use a spreadsheet Annual and Quarterly reports are snapshots; economic entity depicted is actually continuous. Management disclosures in a competitive environment; strategy vs. economic and industry trends, changing business models.

How to Read Company Financial Reports

Bill Roberts 202 329 7157 wroberts3@mac.com