Most people would prefer to avoid reading 100-page documents whenever they can, but lengthy and technical 10-Q and 10-K filings from the Securities and Exchange Commission (SEC) are generally a necessity for investor success.
Fortunately, these filings consist mostly of routine descriptions and disclosures that can be avoided, and this article will take a look at how to speed-read these filings to quickly pull out the important information.
- Most 10-Q and 10-K company filings with the Securities and Exchange Commission (SEC) have routine descriptions and disclosures that can be avoided.
- SEC filings are useful as they provide updates from companies, as well as key financials.
- The "Financial Statements and Supplementary Data" section represents the meat and potatoes of the 10-Q and 10-K, providing a comprehensive financial overview.
- The "Management Discussion and Analysis" section is perhaps the most important section of the 10-Q or 10-K filing and helpful for investors to read in its entirety.
- The "Footnotes to the Financial Statements" contains important information that can help investors avoid potential fraudulent situations.
Why Read 10-Q and 10-K Filings?
SEC filings provide investors with a useful and reliable source of information, as companies are required to routinely update shareholders. Aside from the quarterly and annual financial statements contained within these filings, investors can also look behind the numbers and discover why the results fell short of, met, or beat expectations for the period.
Effectively reading these SEC filings can also help investors steer clear of fraudulent activity by uncovering certain types of accounting fraud. For example, companies may try and switch inventory accounting to more favorable accounting types or mask drops in net income by adding or subtracting non-cash elements—all of which become visible in these filings.
Finding SEC Filings Online
SEC filings can be found on the SEC website by going to its EDGAR system. Other third-party websites, such as SECFilings.com, also provide the data along with other value-added services to help investors sort and digest the SEC filings.
A Look Inside 10-Q and 10-K Filings
Investors looking at a 10-Q or 10-K filing for the first time may be a bit surprised by the size of the document, which can often be in excess of 100 pages. However, all of these filings are divided into easy-to-understand sections in order to make them easier to follow. These three sections include:
- Business overview—A description of the business, risk factors associated with the business, legal proceedings for and against the company, and matters to vote on, among others.
- Financial overview—A review of the company's performance over the period, management's discussion and analysis of the results, changes in accounting procedures or disclosures, and supplementary data, among others.
- Governance overview—A review of executive compensation, beneficial ownership by management, relationships with directors, and accounting fees, among others.
While all of these sections contain important information for investors, there are a lot of regulatory disclosures that can be ignored. In the following section, we'll look at a quick three-step process to quickly ascertain the information needed in just minutes.
3 Key Steps to Speed-Reading SEC Filings
The key parts of 10-Q and 10-K filings are balance sheets, income statements, and cash flow statements.
The balance sheet is a review of the company's assets versus its liabilities; this is useful for checking liquidity ratios, cash on the books, and the level of debts owed to others.
The income statement is a review of the company's revenues and profits; this is useful for seeing how the business is performing on the top and bottom lines. Meanwhile, the cash flow statement is a review of cash flows in and out of the bank; this is useful for cross-checking with the income statement to verify net income figures.
1. Get Information From the Source
The "Financial Statements and Supplementary Data" section represents the meat and potatoes of the 10-Q and 10-K, by providing a comprehensive financial overview of the period.
Investors should begin analyzing this section by computing the percentage increase or decrease versus the prior period and comparing the numbers to expectations.
Next, investors should compute key ratios, such as the current ratio, and look at long-term debt and cash levels to ensure that no problems exist on the balance sheet.
And finally, investors should take a look at the cash flow statement to make sure the cash coming through the door is from the business's operations, and not from creative accounting.
2. Get the True Story Behind the Headlines
The "Management Discussion and Analysis" section is perhaps the most important section of the 10-Q or 10-K filing and helpful for investors to read in its entirety.
Investors should read this section in its entirety to understand the reason for changes in revenues, margins, and other metrics on the financial statements. Essentially, this section provides the true story behind the news and headlines showing just the numbers.
The section can also contain guidance for future periods as well as additional notes, such as updates on major contracts, which are necessary to create accurate earnings and revenue forecasts for future quarters or years.
3. Check for Accounting Irregularities
The "Footnotes to the Financial Statements" contains important information that can help investors avoid potential fraudulent situations. The most common areas for fraud include:
- Revenue recognition—Some companies recognize revenues before they receive payment or deliver goods, which can make revenues appear stronger.
- Intangible assets—Some companies place an unreasonably high value on intangible assets, which can make the balance sheet appear stronger.
- Depreciation—Some companies change the way assets are depreciated to a more favorable method, which can lead to higher non-cash income.
There are countless ways for companies to inflate income and assets or hide losses—from recognizing revenues before they should to underestimating doubtful accounts—but everything is disclosed in the footnotes. Therefore, it is important for investors to check these footnotes, especially when things look suspicious on the financial statements.
The Bottom Line
While 10-Q and 10-K filings may seem intimidating at first, they can be quickly scanned for important information in just three steps. Using these techniques, investors reading these documents can avoid misleading news headlines and understand the true story behind the scenes, as well as avoid potential fraud in just minutes instead of hours.