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, they're 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.

Reading Quarterly and Annual Reports (Part

)

January

, 2011

Staff