Companies bury the juicy stuff. Here's how to find it.
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Ready to channel your inner detective? Good, because smart investors need sleuthing skills in order to read the documents that publicly traded companies file with the SEC. You need these skills because although companies have to disclose certain things, they don't have to make it easy for you to find them. It's possible that the information you need to make an informed investing decision is buried in a tiny footnote on page 384 of a 600-page document! How do you avoid falling prey to companies that try to hide critical information? Try some of the techniques that the team at Footnoted.com uses.
Companies must file lots of public documents, but the important ones that any investor worth his or her salt should pay attention to are the 10-Q, 10-K, 8-K, and proxy statement. Companies file a 10-Q 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. Companies must file an 8-K to disclose a significant event that occurs before the next quarterly report is due. Proxy statements are filed annually, ahead of the annual meeting. The SEC puts all public filings on EDGAR, its free online database. Filings are also available through subscription-based services and on company websites. It takes around 30 minutes to skim a 10-Q or proxy statement, less time for an 8-K. Leave an hour to read a 10-K.
Try to make time to at least scan an entire 10-Q, but if it's too long, focus on these sections: Management's Discussion and Analysis of Financial Condition and Results of Operations, Legal Proceedings, Risk Factors, and Exhibits. In the first three of these sections, you're looking for new disclosures. (Search for terms such as "2010" and "material adverse effect.") In Exhibits, pay attention to new employment agreements and separation agreements. Does the company promise an executive a guaranteed cash bonus, regardless of how well the company performed? That was the case at Martha Stewart Living Omnimedia MSO, where the stock price and executive compensation have sometimes seemed curiously out of sync.
You're also looking for new disclosures in a 10-K--especially anything that has a material adverse effect on the company's performance. So, concentrate on the same sections you did in the 10-Q but also look for mentions of settlements, environmental and tax problems, labor problems, plant closures, and significant lost contracts. These could be mentioned anywhere.
Some 8-Ks simply report earnings or accompany a press release, but others are far more important. Wellcare Health Plans WCG, for example, filed an 8-K on April 23 to announce the resignation of its audit chairwoman, Regina Herzlinger. Herzlinger mentioned accounting problems and her belief that she was being expelled from the boardroom because she asked difficult questions. Wellcare rebutted that Herzlinger was just upset that she wasn't nominated to run again as a director. Regardless of who's "right," this 8-K was a neon sign that warned Wellcare's investors: "Pay attention!"
Proxy statements often contain meaty information. Look for shareholder proposals and the board's reasoning for why it supports or opposes the proposals; directors' compensation; executive compensation, including perquisites, the Summary Compensation Table (and its footnotes!), and sections that explain any bonuses and equity awards that the board is giving; and related party transactions.
Investors deserve all of this information because the company is using their money to operate. Remember, if the company is lavishing its CEO with unlimited personal flying time (as Michael Jeffries of Abercrombie & Fitch ANF got in 2009, when he racked up $1.1 million worth of time on the company jet), shareholders are footing the bill. When you spot the disclosures and clues that help you make better investment decisions, you'll feel like you've just solved a great mystery. And, in fact, you have!
Sonya Hubbard is a reporter and researcher for Footnoted.com.