Reading Quarterly and Annual Reports (Part Three)

In parts one and two, we learned who files quarterly and annual reports, what sorts of key

information we can pull right from the top, and what sections are worth delving into. Our

intention in this series is not to get into the numbers, but rather, address ways to save

yourself valuable time, and build a general research philosophy.

Towards the bottom of these reports, we'll find Item 3 (Item 7a in annual reports),
“Quantitative and Qualitative Disclosures about Market Risk”. At first glance, this may look
like standard boilerplate fine print that no one reads. As we start reading a little bit, however,
we quickly discover that these disclosures are very specific to the company and industry.
Please note that you may need to refer to the 10K, as the 10Q may not include any changes
since their last annual filing. Also note that this section may be omitted for smaller
companies.

What we want to focus on in the risk

disclosure is how it relates to

management's discussion and

analysis of financial condition and

results of operations. The risk

disclosure may contain information

about foreign currency, interest rate,

commodity price and other risks,

and what the company is doing to

manage these risk's. Are they

engaging in any hedging activities?

How much of the risk, if any is

covered by the hedging? Does the

risk relate more to the companies

revenues and profits, or to the

companies investment activities or

cash holdings?. Once we see and

understand managements master

plan for risk control, we can look

back at their discussion of results to

see how well the plan has been executed, and how much these risk factors are really
affecting results.

Although the risk disclosures are fairly thorough, you must understand that other risks may
exist that are not discussed or foreseen, in fact, this is the very definition of the word risk. We
can look at a few more items specific to the annual report that may include information about
risk, even if the company is unwilling to admit that they are material.

One place to check is item 9, “Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure”. It will be rare to find anything here, but it is definitely
worth a quick look. Item 9a, “Controls and Procedures” may also contain industry specific
information as to how the company tries to assure us that their financial reports are accurate,
and not fraudulent. In theory, the more policies and procedures the company has in place,
the more assurance we can gain. One more place to look is item 11, “Executive
Compensation”. Although this information is totaled up and easily located without the use of
the report, the filing really delves in and breaks everything down for you. Perhaps the most
important thing to note in this section is whether or not the company uses stock options and
other dilutive means exclusively or almost exclusively to pay their executives, employees and
consultants, or are the stock options just supplemental. If the company is paying everyone
with shares rather than cash, it is safe to assume that the only place the stock can go is
down, sometimes in robust fashion.

The timing of these filings can be key to how the stock responds. For example, if a company
releases their financial results on a Friday after the bell, chances are it doesn't include what
the company was hoping for. In contrast, reports filed right before the market opens are
generally viewed as positive. It is also important to note when the accompanying press
release is issued. Is the company so excited about their results that they can't wait to tell you,
or would they rather keep things subdued. The bottom line here is that ultimately, the
company cannot hide from these reports, and if they don't file or are habitually late, they
simply will not earn a passing grade.

One more thing to note is how the company compares it's income statement, balance sheet,
and statements of cash flow to previous results. Is there consistency, or are they comparing
the income statement to last years comparable quarter and the balance sheet to the last
consecutive quarter. Are they totaling year to date figures, six month figures, or from inception
figures. Chances are they will pick whatever looks best. This is why it's best to look at the
statements through the lens of a third party, where they are all compared the same way. One
last thing worth noting when comparing financial statements is what sort of time frame the
company uses, fiscal or calendar years. Generally, time frames are consistent throughout
specific industries, making comparing competitors a bit easier. Just remember to look at
how the time frame compares with overall market strength or weakness, as well as what
quarter major events actually fall in.

Reading Quarterly and Annual Reports (Part Three)

ebruary 7

, 2011

Staff