Research means that you don’t’ know but you are willing to find out.
Research is an indispensable part of your life especially when you are an investor. The greatest of all investors like George Soros and Warren Buffet have a keen eye for researching. Research in the stock market is super-fun as it helps you build wealth.
However, in order to become a good researcher, one needs to take a closer look at the financial documents of the company. It is because in the world of stock market
People Lie, Numbers Don’t.
The financial documents contain the following pieces that one needs to decode with Sherlock’s eye.
- Chairman’s Letter
- Sales and Marketing
- CPA Opinion Letter and the 10K Document
The letter from the chairman of the company usually starts by greeting its investors explaining how the company has prospered throughout the year. Most of the letters try to put the performance of the company in positive light. In order to decode the letter, you need to look answers for the following questions:
- How is the industry doing with respect to the company?
- Is the company investing in Research and Development?
- Does the letter contain any apologies for underperforming?
Sales and Marketing
This section throws light on the income statement and the balance sheet of the company. Most of the companies have one core product that they sell in.
For Example: Coca-Cola deals in beverages and Mercedes manufactures luxurious cars. Now, if you find that Coca- Cola is making more profit in its sheet by selling a subsidiary product and Mercedes is garnering income by manufacturing affordable cars, is there something that you should be suspicious of?
As a company, it is important that your core product should always sell well. It is because the core selling point defines the USP (Unique Selling Point) of the company. Losses or lower sales in your core product means either the management is incompetent in managing the company or the quality of the product has degraded.
In order to decode the sales and marketing, look for answers to the following questions:
- How is the company doing with respect to the industry?
- Are sales and profits increasing and if not, then what could be the reason?
- How well is the company performing with respect to its competitors?
CPA Opinion Letter and Form 10K
CPA opinion letter, also known as the accountant’s letter states an opinion of how true and fair are the financial statements of the company.
Form 10K is a report that the companies must submit to the SEC annually. This report contains a complete report on the financial activity of the company.
When looking at CPA Opinion Letter and Form 10K, ask yourself the following questions:
- What are the strategic plans by the management?
- Has the management successfully implemented its plan over the course of 5 years?
- Are income statement and cashflow positive?
- Are there any significant lawsuits pending against the company that could sabotage its reputation?
In order to understand, if the management is capable of implementing its plan, use the Buffet’s 5- year Approach.
Buffet’s 5-Year Approach
Warren Buffet analyses the annual reports of the company from the last 5 years. He carefully reads the plans of the management and sees if they were able to implement it over the course of 5 years. If the reports suggest otherwise, he drops the plan of investing in the company.
Brokerage reports contain valuable information maintained by professionals and are issued by brokerage firms. It is important to read the brokerage report of the company and get a second person’s opinion. If you are making investments through a firm, the reports are available to you free of cost.
However, you should never formulate an opinion solely on the basis of Brokerage reports. Do your own research first.
When reading the brokerage report, check out the following questions:
- Is the report biased towards any company?
- Is your research consistent with the information given in the report?
In the bubble of 1998–2000, brokerage reports positively about Internet-based companies like eToys.
eToys was a website that sold the toys via the Internet. When the company public in 1999, the stock price increased manifold. The shares that were issued at $20 increase in value to $76, by the end of the day. As a result of this, the company entered the dot-com bubble. In a period of 1 year, the bought out of bankruptcy by KB Toys sinking the money of millions of investors.
Financial reports offer great insights about a company. One can avoid a bad investment by simply analyzing the report. However, when analyzing one should carefully look for the answers to the questions stated above.
Diligent research is what separates an investor from a speculator.
Invest Wisely! Happy Investing 🙂
This article is for informational purposes only, it should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions