Inside Footnotes | footnoted.com

How do you read all those SEC filings?

From footnoted.com

Inside Footnotes

Any investor who wants to pick their own stocks needs to feel comfortable reading, or at least skimming, a company's 10-Q, 10-K and proxy statement. Investors should also pay attention to several other key forms, including 8-Ks, Form 4s (insider trading) and Schedule 13Ds. All of this information is available on the SEC's EDGAR database and on various subscription-based websites. While the SEC site is free, if you're looking at multiple filings for several different companies, the SEC's site is much more cumbersome to use than the various subscription-based services. Most companies also post this information on their own websites, typically in the "investor relations" section of the site.

Companies file 10-Qs three times a year, usually about a month after the end of their first, second, and third quarters. Information for the fourth quarter is included in the 10-K, a much more detailed version of the annual report that typically comes out about two months after the end of the company's fiscal year. Companies file proxy statements annually and typically send a copy to investors in the mail, although they may be available sooner electronically.

Once you become familiar with these documents, looking for a few key items shouldn't take much time — figure around 30 minutes to skim a 10-Q or a proxy and an hour for a 10-K — and could save you a lot of money by helping you avoid potential problems.

Remember: there's no need to read every word or even understand everything that you are reading. What you're looking for are significant changes that were not in the filing last quarter or last year. What makes something significant? That's difficult to say. It's kind of like the way the Supreme Court defines obscenity: you'll know it when you see it.

Also keep in mind that reading SEC filings is more of an art than a science. The language used in SEC filings — a mix of accounting-speak and legalese — takes some getting used to. When it comes to risk factors, for example, companies often list every conceivable possibility, even if the likelihood of that specific lightning strike is very rare.

With that in mind, here are a few suggestions on what to look for in these documents:

Quarterly:

• How does net income compare with pro-forma income? What is the company excluding to arrive at the pro-forma number and does it make sense?
• Are there any sizable differences between the numbers reported in the quarterly earnings release and the 10-Q?
• Does the company consistently report "special charges" quarter after quarter?
• What impact (if any) have restructuring charges had on the quarterly earnings?
• What impact (if any) have stock options had on the quarterly earnings?
• Have there been any significant changes to lawsuits that the company is involved in?

10-K: (in addition to the above questions)

• Are the company's deferred income taxes growing? What is the company's effective income tax rate?
• Has the company made any changes in the way it recognizes revenue or accounts for its expenses?
• How is the company handling its debt? Is the new debt at favorable interest rates?
• What sorts of related party transactions is the company including and how does this compare to the disclosure in the proxy on related party transactions?
• What is the company including in its other assets/liabilities other income/loss? Are derivatives a substantial component of these numbers?
• How has stockholder's equity changed over the past year?

Proxy:

• How many times did the audit committee meet in the past year? Does the audit committee seem to have enough experience and independence to ask tough questions of company management?
• What types of related party transactions are being disclosed? Has there been a substantial increase in these transactions? Do they seem reasonable?
• How much stock do executive officers own? What about the directors?
• Do executive salaries correspond in any way to the company's financial performance over the past year?
• Do the retirement benefits for executives (including pension benefits) seem excessive given the company's performance?
• How much is the company paying its accounting firm for non-audit services? How does this compare to previous years?
• What sorts of shareholder proposals are being included in the proxy? Do they raise concerns about the company's approach to corporate governance?

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