Analysts – Your Business Detectives.

The analysts that I have met are by and large the brightest, most intelligent people in the business world.  Few, if any, would know how to run a lemonade stand, let alone a real business, but from an intellectual viewpoint, they provide mostly free insightful and highly relevant material on public companies.  Here are a couple of points to consider when reviewing their reports:

•       Everyone wants a Watergate, unless….  Analysts live to find the errors and hidden facts in documents.  This is their prime motivation (along with the astounding compensation they typically receive!).  Reputational fame in their culture rests on being the first to identify the problems that lead to eventual doom and gloom.  They are not looking for good news, in general, unless….

•       Their firm is doing the banking!  Again the conflict arises of banking and analysis being under the same roof.  The best analyst reports are from those firms that have absolutely no skin in the game – but this is a condition that can be argued for and against for many of the fringe analysis firms that claim this hallowed ground.  Most have some sort of tangential connection.

•       Thus, the source is often more important than the content to determine underlying intentions and potential veracity of the data and conclusions.  Buyer beware! 

•       Remember, not just with analysts but in a very general sense, most numbers can be shaped and used to tell a story someone wants to tell.  Just because the analysts says his/her conclusion is sound, you have to remember that they have no motivation to state their conclusions are shaky and unfounded!

10K and 10Q Reports – You Can’t Hide!

I love the 10-K and 10-Q reports!  These are legal documents where everything is disclosed – hidden often – like in a set of nesting Russian dolls (matryoshka nesting dolls) but still there if you know where to look.

•       Required for all public companies, you may not have this document for private or oversees companies unless required by the Dodd act.

•       Very, very boring read – often the more boring the text, the more they are trying to bury.

•       Format dictated by the FTC so forget usability – although once you learn to read one of these you will quickly know how to read the next one.

•       Very, very, very capable of being used in court.  So they don’t explicitly lie here – they can mold, shape and influence - but they face possible criminal and civil prosecution if they intentionally lie.

•       All the fun stuff – what they are paying senior people, who owns how much stock, actual inventory problems, reserves for losses, pending lawsuits and litigation, etc.

•       This is where the analysts hunt.  This is the bread and butter of the public disclosure research database.

Annual Report – A Mainstay of Information!

This is truly a treasure trove of basic information – just recall that it is also a marketing document to investors and will paint a very rosy picture of the company.  Some of the key data are:

•       General Corporate Information.

•       Chairperson’s statement.  Normally complete fluff that the Chairperson most likely didn’t write but did review prior to signing; expect only the good news, great progress and wonderful futures here!

•       Operating and financial review.  Each division or sub-business unit within the company structure will be reviewed for their individual results.  Look for the stars and dogs of the company.  For years, the General Electric report was a glowing review of every division except for the consumer appliances and light bulb divisions – they eventually were sold….

•       An audited balance sheet (they can’t lie here – but they can apply many different accounting policies and principles (FASB) in accordance with variations or interpretations allowed by accounting rules and regulations – and they do tend to hide many things in this particular financial report!)

•       An audited cash flow statement.  Same issue as with the balance sheet.

•       An audited profit and loss statement.  Same issue as with the balance sheet.

•       Accounting policies that they use in the report.  Pay close attention to this area as it can be very impactful on the financial statements. 

•       Notes to the financial statements.  These are the nuggets that you’re looking for.  In these notes they will disclose how they are interpreting or applying accounting principles. 

•       Director's Report.  Another canned letter written for the Chairman of the Board of Directors on their assessment of the company’s performance.  I would skip this – it rarely contains anything of real marketing value.

•       Auditors report.  The auditors will provide a brief letter that will explain that they have reviewed the books and financial statements of the company and that they either concur with the calculations or that they have found exceptions.  The latter never happens.  The company will make sure they satisfy the auditors requests to ensure that the letter is positive.  But another big caveat here – the auditors are not making an assessment as to the validity of anything other than the application of accounting principles applied by the company.  This does not mean that all the information is exactly correct or that they are in total agreement with the application of the accounting principles – just that in their opinion, they were reasonably applied in the report.

Finding the REAL sub-goals of a company.

Like Indiana Jones, we are left to dig up our own conclusions as to the real sub-goals of the company.  There are often plenty of resources to discover these little treasures.  Here are just a few:

•       Annual Reports.  Publically traded companies are required by law to publish an annual report to all shareholders.  Look under “investor relations” on the company's main website to find a quick link.  Just recall that annual reports are the purest form of biased public relations a company produces.  I once had a professor at Harvard Business School exclaim that the goal of the company was to tell the best possible story of the operating results and the goal of the outside analyst was to find all the hidden lies.

•       10-K.  This is a Security and Exchange Commission (SEC) required filing.  The “K” designates that this is the summary annual filing.  This is a gold mine.  It is not a public relations document at all.  In fact, it is produced in one of the most unfriendly and marketing agnostic formats you will ever see.  It looks like (probably because it is) a legal document.  No pretty pictures here – just the facts.  They disclose EVERYTHING the company has to disclose by law without the ability to dress it up for the window shoppers that peruse the annual report. 

•       10-Q.  This is the quarterly filing version of the 10-K.  While not in as much detail as the 10-K it is still a gold mine for quarterly performance.

•       Analysts Reports.  All the enormous firms on Wall Street employ thousands of the best and brightest minds available to decipher what companies are reporting to the public.  You would think these would be unbiased and of great value.  The problem lies in the natural conflict between these large Wall Street firms’ banking operations and their analysts.  Bankers want the stock price (and thus all the analysis) to be positive.  Analysts want to tell the truth – but are paid by the bankers.  Guess who wins that standoff?  While there are plenty of provisions for barriers within each firm to ensure this banker-analyst conflict does not occur, you would be foolish to believe there is any real separation of influence.  So read analysts reports with a grain of salt – some of it might be really good – particularly if their banking operations have absolutely no connection at all to the company they are analyzing.

•       Google.  Crazy, but Google is another great source.  Simply Google the company name, board member names, senior management names, etc. and you will find all sorts of information on what they have told the press about the company’s goals and the progress they are making in achieving them.  Here you have to keep in mind that you get what you pay for.  If the information is free, you have to remain skeptical without real verification. 

•       Company’s website.  A company will often release vast amounts of information on their own PR website.  Just remember the author (the company) has a real vested interest in telling you the story they think puts them in the best light.  No way are they going to voluntarily send out a press release saying they have been dumping toxic waste into the local rivers without some sort of outside mandate.

Company Goals - Where Do I Find This Information?

Whether you're in a company or the company is a client, it is shockingly common to discover that very few people actually know the goals of their company/client!

How could this be?  I am not suggesting that no one at the automobile manufacturer understands that the goal is to sell more vehicles at greater profit.  But this is what I refer to as pushing a boat with a rope.  Obviously, no matter how much you “push” on a rope tied to a boat (unless it’s physically in contact with the vessel) you are not going to move it!  So goals such as the below are not inconceivable to the casual observer/employee:

·      Sell more cars

·      Sell more trucks

·      Reduce the cost of building a car by 10%

·      Reduce the cost of people used in building the cars

But what do any of the above mean?  I call the above “directly unachievable goals.”  They cannot simply be mandated.  You must apply the formula we discussed earlier of Y = f (x) in order to focus efforts and measure the results of those efforts on what makes selling more cars or reducing costs possible.

Since it is not uncommon to have no idea what your company/client achievable goals are, you have to discover what they are independently.  We'll discuss that in tomorrow's blog.

Let me interject here that senior management is not stupid.  It’s not as if they are ignorant of the Y = f (x) relationship!  They are just generally very ineffective or lousy communicators of these sub-goals to the rest of the company.  The irony is that they are often surprised at how little people are “on board” with their vision or plan when they have never really aligned and communicated what they are trying to accomplish!