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 are a necessity for 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.
How to Speed-Read an SEC Filing
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 becomes visible in these filings. (See also: SEC Filings: Forms You Need To Know.)
Finding SEC Filings Online
SEC filings can be found on the SEC web site by going to its EDGAR system. Other third-party websites, such as SECFilings.com and EDGAROnline.com, also provide the data along with other value-added services to help investors sort and digest the SEC filings. (See also: Policing The Securities Market: An Overview Of The SEC.)
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, 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.
Three Steps to Speed-Reading 10-Q and 10-K Filings
- Balance Sheet—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.
- Income Statement—A review of the company's revenues and profits; this is useful for seeing how the business is performing on the top and bottom line.
- Cash Flow Statement—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.
- Get the 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. The section includes:
Investors should begin analyzing this section by computing the percentage increase or decrease versus the prior period and comparing the numbers to price-earnings multiples and expectations.
Next, investors should compute the current ratio by dividing current assets by current liabilities, 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. (See also: Fundamental Analysis: Introduction To Financial Statements.)
- Company Description—A review of the company's historical and current operations, as well as a briefing of the company's industry.
- Operating & Financial Results—A review of the company's operating and financial results for the quarter, including reasons for changes in results, margins, or other metrics.
- Future Guidance—A projection of the company's expected performance during the next quarter or year, based on management's opinion and judgment.
- Additional Notes—Any additional notes or comments that management would like to convey to shareholders or potential investors, such as contract news/awards.
- 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. The section includes: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 addition notes, such as updates on major contracts, which are necessary to create accurate earnings and revenue forecasts for future quarters or years. (See also: Top 9 Questions Investors Should Ask Management.)
- 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 one-time 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.
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. (See also: Don't Forget To Read The Prospectus!)