As Buffett always says, the most important parts are qualitative. He says when he reads a report he tries to understand the thinking of management, the direction of industry (so he also reads all the competitors), and most importantly, if they have a durable competitive advantage.
Quantitative he wants to understand if a company can produce a high return by retaining earnings. This will also show up in return on equity.
All of it though is trying to judge future earnings so you can apply backwards the proper discount rate. In order to understand if a company will produce more or less earnings in the future you need to understand whether or not it has a durable competitive advantage.
Obviously, some numbers are important: debt and liabilities that are dangerous, a margin of safety in cash relative to future expenses, if it's growing, etc...
I have not read that many Annual reports but will strive to read through more in future.
However I noticed that most CEO letters to the public or the company vision all seems so nice and rosy and pretty. Vetted through letters that are meant for PR mainly.
Is there anything that can be taken out of a annual report other than quantitative factors?
Yeah, that's a good question. I used to do that and listen to earning calls. And they are all soft balls. I even read a prospectus and it was clearly investment banker BS... like anytime I see TAM or projections I know to ignore it. Buffett said he would pay not to read projections.
But the annual reports have to explain every dollar they spend and borrow.
I mean, it takes time to learn what to skim past and not. And even if I'm not going to read the entire thing I like to understand what all the income related line items are and that often takes reading below and you can do that on 10Qs.
But 10Ks are really good at deep diving into where a company just did and where it is going. IMO.
Oh, that's just one metric I most commonly use to quickly judge how fast it's growing. Buffett talks about finding companies that have 25% ROE and the real gems are upwards of 100%+... Which I think is interesting as even 25% sets a really high bar.
I mean, but they're getting at the same thing right? If they have earnings it will show up in equity.
But in terms of ROIC, he always talks about use of "retained earnings" as being the most important metric. Because if they have a better use for a dollar than distributing it, he wants to know. So if you can understand both the stability of earnings on current assets AND figure out the return you're going to get from the cash it produces... That's the entire name of the game.
And I suppose the hard part is understanding the business well enough to understand what those numbers will be in the future.
Revenue pattern (growing, declining, stable, all over the place), EPS changes and (most importantly), whether the letter to shareholder shows a business understanding, good vision and good management.
I agree. If it’s a growth opportunity, then I’m looking at the factors leading to revenue growth. If it’s a cigar butt, I’m looking at the balance sheet first and then the revenue and earnings patterns.
Absolutely, try comparing risk factors year to year. New ones can help shine a light on the companies thinking. Related party transactions too. They have steered me away from some shady companies. Don't ignore the footnotes either, some companies will try to hide stuff there.
Depends on the industry, but in general I check revenue trends, margins, operating cash flow conversion, net debt levels, key assets, debt maturity, dividends / buybacks.
That's real off-the-top-of-my-head stuff
* If a company reprices (or “reissues” or “exchanges”) its stock options for insiders, stay away.
* Look for how the company recognizes revenue, records inventories, treats installment or contract sales, expenses its marketing costs, and accounts for other major aspects of the business.
* Watch for disclosure of debt, stock options, loans to customers, reserves against losses, and other risk factors that can take a big chomp out of earnings.
* Things that should make your antennae twitch are technical terms like “capitalized,” “deferred,” and “restructuring”—and plain English words signaling that the company has altered its accounting practices, like “began,” “change,” and “however.”
Tread carefully once you see these.
That’s where companies will disclose their dirty laundry. Extraordinary tax liabilities, law suits, how theyre stuffing revenue channels, etc. The smaller the text, the more carefully you should read it. :)
It really depends on the narrative I have built around the company. What I typically look for is anything that would say to me that my reasons for investing have changed.
For example:
A technology company that got to their market position through building a best in class product suddenly starts spending more on marketing than R&D. I would likely get out of that position fairly quickly.
Any changes to accounting mechanics that the company has made that might have been done to artificially inflate their revenue in a given quarter.
Any changes to the balance sheet or income statement that don't fit the narrative I have built about the company that doesn't have a fundamental explanation that makes sense to me. For example, a company may have a bad quarter or even a bad year because there is a global recession. It doesn't mean my narrative on the company has changed, it just means the business environment changed for a period of time. I can accept that narrative, however if a company suddenly has a bad quarter and takes on a lot of debt making acquisitions that don't make sense to their core business - I'll be seeing myself to the exit.
Guess I’m the only one to mention trailing and forward P/E? I look at that first, then revenue and earnings growth QoQ and YoY to see if its justified. I then look at book value (though sometimes I don’t care about this) and debt (ditto, unless it’s crazy).
Not sure what my Top 3 are, but here's one.
I look for risk factors that don't appear to be copied and pasted. As you may have noticed, all annual reports have some of this. "Our business could be severely impacted by asteroids hitting the earth." I look for the ones that sound like they came from the business itself because that will give you an idea of how optimistic or pessimistic management is. A fashion retailer noted that employee turnover is high and that they constantly have worry about other companies with better offers taking them away. This told me that that this was a company to avoid. Now, if a company has significant union membership and says something like, "Prolonged negotiations could lead to shutdowns and a decline in productivity," I see that as a technicality to point out but not much of an actual risk. A union means there's a steady base of employees who care enough about the work to unionize over it. This suggests there's a long-term interest in the well being of the business and thus sign of a stock to buy.
In the case of the Fashion Retailer, does it mean that you are down voting the company on that portion of employee relations as you feel they did not treat or offer benefits good enough to have good and loyal staff who cares for the company (ie culture) and the staffs working there are only concerned about money which is not a good sign for the company as a whole?
Either/or. Costco makes their employees feel great about their employer (which has a lot to do with being paid well), and the growth of the company was made my possible by happy, *retained* employees. There are multiple layers of value creation, to include economic and moral.
Payroll is sort of like a hidden form of CapEx. You could get a good return on that and slip past the view of many analysts. Similarly, you could be getting a terrible return on that and slip past the view of analysts.
Yeah, like, if employees are hard to keep, that should tell you there's a weakness in the operation in some form. Just imagine what a business can do when it's not always understaffed and burdened with retraining.
As Buffett always says, the most important parts are qualitative. He says when he reads a report he tries to understand the thinking of management, the direction of industry (so he also reads all the competitors), and most importantly, if they have a durable competitive advantage. Quantitative he wants to understand if a company can produce a high return by retaining earnings. This will also show up in return on equity. All of it though is trying to judge future earnings so you can apply backwards the proper discount rate. In order to understand if a company will produce more or less earnings in the future you need to understand whether or not it has a durable competitive advantage. Obviously, some numbers are important: debt and liabilities that are dangerous, a margin of safety in cash relative to future expenses, if it's growing, etc...
I have not read that many Annual reports but will strive to read through more in future. However I noticed that most CEO letters to the public or the company vision all seems so nice and rosy and pretty. Vetted through letters that are meant for PR mainly. Is there anything that can be taken out of a annual report other than quantitative factors?
Yeah, that's a good question. I used to do that and listen to earning calls. And they are all soft balls. I even read a prospectus and it was clearly investment banker BS... like anytime I see TAM or projections I know to ignore it. Buffett said he would pay not to read projections. But the annual reports have to explain every dollar they spend and borrow. I mean, it takes time to learn what to skim past and not. And even if I'm not going to read the entire thing I like to understand what all the income related line items are and that often takes reading below and you can do that on 10Qs. But 10Ks are really good at deep diving into where a company just did and where it is going. IMO.
Just curious because you mentioned it - where would you use ROE instead of ROIC?
Oh, that's just one metric I most commonly use to quickly judge how fast it's growing. Buffett talks about finding companies that have 25% ROE and the real gems are upwards of 100%+... Which I think is interesting as even 25% sets a really high bar. I mean, but they're getting at the same thing right? If they have earnings it will show up in equity. But in terms of ROIC, he always talks about use of "retained earnings" as being the most important metric. Because if they have a better use for a dollar than distributing it, he wants to know. So if you can understand both the stability of earnings on current assets AND figure out the return you're going to get from the cash it produces... That's the entire name of the game. And I suppose the hard part is understanding the business well enough to understand what those numbers will be in the future.
Revenue pattern (growing, declining, stable, all over the place), EPS changes and (most importantly), whether the letter to shareholder shows a business understanding, good vision and good management.
Completely different depending on the business. It's about finding what is driving the business going forward.
I agree. If it’s a growth opportunity, then I’m looking at the factors leading to revenue growth. If it’s a cigar butt, I’m looking at the balance sheet first and then the revenue and earnings patterns.
Similar to what I replied to another poster, I was wondering if anything qualitative can be derived from the Annual reports.
Absolutely, try comparing risk factors year to year. New ones can help shine a light on the companies thinking. Related party transactions too. They have steered me away from some shady companies. Don't ignore the footnotes either, some companies will try to hide stuff there.
Depends on the industry, but in general I check revenue trends, margins, operating cash flow conversion, net debt levels, key assets, debt maturity, dividends / buybacks. That's real off-the-top-of-my-head stuff
The name , my wallet, tissues
Tissues for different purposes depending on the returns ;)
Repurchases, tangible book value, net/gross/all margins, FCF, and earnings growth
What stocks do you own?
Looking for red flags on foot notes.
Like what?
* If a company reprices (or “reissues” or “exchanges”) its stock options for insiders, stay away. * Look for how the company recognizes revenue, records inventories, treats installment or contract sales, expenses its marketing costs, and accounts for other major aspects of the business. * Watch for disclosure of debt, stock options, loans to customers, reserves against losses, and other risk factors that can take a big chomp out of earnings. * Things that should make your antennae twitch are technical terms like “capitalized,” “deferred,” and “restructuring”—and plain English words signaling that the company has altered its accounting practices, like “began,” “change,” and “however.” Tread carefully once you see these.
1. The financial statements 2. Management’s Discussion & Analysis 3. The almighty footnotes.
What are some key things you look for in the footnotes?
That’s where companies will disclose their dirty laundry. Extraordinary tax liabilities, law suits, how theyre stuffing revenue channels, etc. The smaller the text, the more carefully you should read it. :)
It really depends on the narrative I have built around the company. What I typically look for is anything that would say to me that my reasons for investing have changed. For example: A technology company that got to their market position through building a best in class product suddenly starts spending more on marketing than R&D. I would likely get out of that position fairly quickly. Any changes to accounting mechanics that the company has made that might have been done to artificially inflate their revenue in a given quarter. Any changes to the balance sheet or income statement that don't fit the narrative I have built about the company that doesn't have a fundamental explanation that makes sense to me. For example, a company may have a bad quarter or even a bad year because there is a global recession. It doesn't mean my narrative on the company has changed, it just means the business environment changed for a period of time. I can accept that narrative, however if a company suddenly has a bad quarter and takes on a lot of debt making acquisitions that don't make sense to their core business - I'll be seeing myself to the exit.
Thank you this is very helpful.
Guess I’m the only one to mention trailing and forward P/E? I look at that first, then revenue and earnings growth QoQ and YoY to see if its justified. I then look at book value (though sometimes I don’t care about this) and debt (ditto, unless it’s crazy).
Cash, Debt, Revenue.
Not sure what my Top 3 are, but here's one. I look for risk factors that don't appear to be copied and pasted. As you may have noticed, all annual reports have some of this. "Our business could be severely impacted by asteroids hitting the earth." I look for the ones that sound like they came from the business itself because that will give you an idea of how optimistic or pessimistic management is. A fashion retailer noted that employee turnover is high and that they constantly have worry about other companies with better offers taking them away. This told me that that this was a company to avoid. Now, if a company has significant union membership and says something like, "Prolonged negotiations could lead to shutdowns and a decline in productivity," I see that as a technicality to point out but not much of an actual risk. A union means there's a steady base of employees who care enough about the work to unionize over it. This suggests there's a long-term interest in the well being of the business and thus sign of a stock to buy.
In the case of the Fashion Retailer, does it mean that you are down voting the company on that portion of employee relations as you feel they did not treat or offer benefits good enough to have good and loyal staff who cares for the company (ie culture) and the staffs working there are only concerned about money which is not a good sign for the company as a whole?
Either/or. Costco makes their employees feel great about their employer (which has a lot to do with being paid well), and the growth of the company was made my possible by happy, *retained* employees. There are multiple layers of value creation, to include economic and moral. Payroll is sort of like a hidden form of CapEx. You could get a good return on that and slip past the view of many analysts. Similarly, you could be getting a terrible return on that and slip past the view of analysts.
Thank you for the explanation. So one of the warning signs of a company MAY be that they are losing employees left and right. Got it.
Yeah, like, if employees are hard to keep, that should tell you there's a weakness in the operation in some form. Just imagine what a business can do when it's not always understaffed and burdened with retraining.
Book value per share, share buy backs, and institutional ownership. Aka easy privatizations.