Everybody knows that Warren Buffett gets his investment information largely from annual reports. Today, companies call him; but, fifty years ago, Buffett was not the go-to guy if you wanted to sell your company or raise capital for your failing bank.
In an interview with Warren Buffett, Adam Smith, author of Supermoney, asked how “regular” investors can find good investment ideas.
Warren Buffett: [Investors should] do exactly what I did forty-odd years ago, which is to learn about every company in the United States that has publicly traded securities, and that bank of knowledge will do him or her terrific good over time.
Adam Smith: But there are twenty-seven thousand public companies.
Warren Buffett: Well, start with the As.
Here’s how.
Your Advantage Over Early Buffett: Technology
When the SEC stole ☺ my idea of RSS feeds for EDGAR filings, they added a great feature – RSS feeds for the latest filings. Rather than subscribing to a particular company’s filings, you can be notified every time any company files an annual or quarterly report.
Among others, I have two of such SEC RSS feeds that come to my Outlook every day:
- Latest 10-K (Annual Reports) – RSS Feed
- Latest 10KSB (Annual Report for Small Business Issuers) – RSS Feed
Last year, more than 16,000 companies filed 10-Ks or 10KSBs with the SEC. Assuming they come in evenly (they don’t, but we’ll say this for simplicity’s sake), that would be more than 4,000 annual reports a quarter, or roughly 44 a day, each and every day of the year. Forget holidays, vacations, or your kids’ birthdays – you’ve got annual reports to read!
Though it sounds like an impossible task, it’s not.
Most Can Be Glossed Over and Discarded
While there is much more to a company than its financials, starting with the financials will allow you to quickly dismiss thousands of these filings. Over the past two days, I’ve looked at more than 500 companies and only found one potential investment – a great company that is slightly overpriced. (Obviously, I’m waiting until it drops 30% or so.)
As an example of companies that can be “glossed over and discarded,” look at this filing from Modena 6, Inc:
I know I don’t need to do a thing but close the filing and move on. The worst part? I had to wait a second while the page loaded.
Another example is this filing (a small business quarterly report) from OmniReliant Holdings (ORHI) – the “Warning” notes are mine:
I’ll spend more time explaining here than I spent actually reviewing the filing itself.
Warning: A Development Stage Company. I don’t like “development” or “exploration” stage companies unless the numbers really jump out at me. When I see “Development” stage, I put my guard up immediately.
Warning: $17.4 million in derivative liabilities compared to total GAAP assets of $14 million (less if we had to fire-sale the businesses). I am gone.
Warning: $29 million shareholder deficit. I didn’t notice this until I posted this, because I didn’t spend more than five seconds on this business.
Bad Businesses? Par For The Course.
Out of 500+ businesses that I looked at, I was able to immediately discard 450 or so because of their negative balance sheets. When a company has a weak balance sheet, everything else about is often highly unstable.
The remaining 98% of the businesses were discarded in under a minute or two. Mediocre balance sheets, massive negative cash flows, and ungodly issuances of stock to managers were the primary reasons for passing. With such weak foundations, such poor past performance, and such disregard (or misunderstanding) of value and the use of stock options, I didn’t need to spend any time figuring out where these businesses would be in the future. When they hit my radar again next year (through the RSS Feed), I’ll see if anything changed.
Thus, to get through 500 or so companies took about an hour, with just three having moved to the “more research” pile. Two of those three were discarded ten minutes later; just one moved to the “yes, but wait for the price to drop” pile.
500 companies an hour x 20,000 or companies = 40 hours a year. Add in additional time for research on the “maybes” and you could get through every filing company in about 60 or 70 hours.
If You Don’t Have a Few Hours a Day
You don’t have to look at every company out there. In fact, you can make very good returns by sticking with familiar brands when they are selling at a discount. But, if you want to spend the time taking your learning and investing to the next level – if you want to “start with the As” as Buffett suggests – the SEC’s Latest Filing Feed is the first step.
Filed under: How to Search for Opportunities
Related Stocks: ORHI
This is a platinum nugget in a gold mine – thanks to the incredibly practical and useful article.
It seems like I could pretty easily comb financials by a screener as the previous poster mentioned, or some public finance site that keeps reasonably up to date on quarterly/annual financial releases.
So beyond that first level filter, what other types of stuff do you look at in the 10K? Is there something else that’s useful in all that text?
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The first thing that came to mind while I was reading this is that if 450 out of 500 businesses in the U.S. are not worth even one second’s consideration and if only 1 out of 500 is worth keeping an eye out to see if it becomes reasonably priced, then no wonder the market is in a meltdown and the bottom is far, far away. I just read somewhere that the S&P 500 just now has hit it’s lifetime average PE of 16, even after this huge sell off…
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If anyone is looking for a book that teaches you how to read Financial Statemnt check this one out at AIER. They just realeased the new eidition last month and it’s only $12. I own the old edition and this book is very helpful to me.
http://www.aier.org/books...;flypage=flypage_new.tpl&product_id=20&category_id=5
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That’s pretty neat that you can screen through that many 10Ks in such a small amount of time. I used to rely on stock screeners, but I moved away from them because a lot of times they make you depend too much on just the numbers and not the business. My approach is learning industries by reading, watching and studying. Some industries I understand and some I don’t, this is kinda my circle of competence. Then I discard the industries that are just bad businesses like airlines! Then I study the market leaders and their competitors by reading 10Ks. If it’s a good business in a good industry with a great price, it becomes an investment candidate.
Although financial statements and numbers are important, I think it’s more important to find a good “business” than just good numbers. You might miss out on great companies that might have a bad 1-2 years. You might also find a couple that have inflated numbers for 1-2 years. At the end of the day, the business makes the numbers, not the other way around.
Another great post and those are some of the ugliest Balance Sheets I seen! Reminds me of some dotcom companies….
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Another 1981 book I got over 30 years ago when local library closed down is still among my best and simplest of all books.
Understanding a Company’s Finances: A Graphic Approach (Paperback)
by W. R. Purcell (Author)
It seems to have gone paperback and is still sold in amazon etc.
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Great post, as always, Joe. Can you explain how you check for “ungodly issuances of stock to managers”? Do you look at options outstanding and available for future issuance compared to shares out? Or do you look at options granted during the year? Do you have some limits like 10% dillution is acceptable but not 20%? thanks
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Wondering if anyone has done any due diligence on YUM yet?
Down 30% in the last month or so. I am going to try to sit down tonight and give it a workup, but if anyone has any comments to start that would great. We can work this one out as a group.
Joe: As always, thanks for the site, this is a great time to exert the tenets of Buffett, Munger, etc. When the world is going crazy, we need to have the confidence to step back on see the big picture, long term. Thanks for helping me do that.
Also, just picked up the new edition of Security Analysis, anyone else reading the new one?
Good luck to all.
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Warren Trivia: In reality, I believe Warren observed while going through the Moody’s handbook that he was finding more jewels near the end of the alphabet and that he should really start at the back of the handbook the next year and work forward.
Leave it to Warren to share the fundamental the priniciple to Adam Smith – read ‘em all, but leave out the secret formula – start at the back 
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Hi Joe
Greetings
Can you please explain the phrase “ungodly issuances of stock to managers”?
What kind of capital structure you look for in a company and Promoters stake in the company.
Also its always a difficult task to understand the capital structure, it would be great if you can make
it simple in some of your post.
Thanks again for your wonderful site.
Regards
Ajay
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john,
No. I don’t go by any hard, fast rules. I’ve bought businesses with debt-to-equity ratios of 2 or 3, companies with current ratios less than 1, horrendous profit margins. The current ratio is, in my opinion, important when looking at liquidations and net-asset plays; but, it’s not a deal breaker for any industry or particular business.
I wouldn’t rule out any company initially (except auto makers and airlines as ongoing concerns) because there’s always something to be learned from each company.
Keep in mind that the current ratio tells you what the company has and owes in the next twelve months, but that can easily and quickly change three months from now. If you only look at companies with current ratios greater than 1, you’ll miss some amazing opportunities in businesses that are getting stronger every day.
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I agree with your/Buffet’s approach
An alternative might be to use the stock screeners at http://indiainvestor.word...
or using the various Free Stock Screeners http://indiainvestor.word...
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