Almost every U.S.-based publicly traded company is required to file reports with the Securities and Exchange Commission, detailing everything from insider and executive stock transactions (Form 4), to special material events (Form 8-K), to regular financial summaries like the quarterly Form 10-Q. Added together, these filings give investors a significant amount of information about a company; but they don't give the full picture.
The most important report, by far, is the Form 10-K. The Form 10-K provides just about everything you'd want or need to know about a company's financials, and they're audited by an approved accountancy firm, giving some measure of reliability to the information.
The catch? There's a solid chance you've never even cracked the cover on a Form 10-K, even though you think you might have. Let's take a closer look at what the 10-K is, what you can get out of it, and how you can use it.
What a Form 10-K is and is not
Many companies release an annual report to shareholders, often including an annual letter from the CEO, at the same time they publish their 10-K. But the annual report to shareholders, while similar, isn't a Form 10-K -- though, to be fair, the 10-K may be included as part of the annual report.
The annual report, as often as not, is used as a tool by management to emphasize the positives while minimizing the potentially bad stuff. The Form 10-K financial report, on the other hand, puts the information out in black and white, and in a consistent format that makes it easy to compare one year against the next. The 10-K must also be filed within 60 days after the end of the fiscal year, though most companies tend to file it within a few days or weeks.
What's in a 10-K?
The 10-K is almost always more detailed than the annual report (again, unless the 10-K is included as part of it), and will have a comprehensive breakdown of the company's financial results, assets like cash and inventory, liabilities like debt and accounts payable, and important things to know, such as executive compensation and risk factors.
The 10-K is structured so that it's easy to consistently find the same information about multiple companies in the same basic place in any 10-K. Here's an item-by-item breakdown of what you'll find in the different sections.
Item 1. Business
In short, what is the company in the business of doing? A company will typically describe its primary business in an overview section, then discuss its business results and developments during the year covered. It's followed with an often very detailed explanation of the business, and the primary markets and customers the business targets. If you're ever not completely sure what a company does, this should leave you with a much clearer picture.
Item 1A. Risk Factors
This is where the company discusses the potential business risks that could harm the business. It can range from risks inherent to a specific industry, like an offshore oil driller's risk of losses from a major accident and oil spill, to something that's broader, like a popular brand losing favor with consumers.
Companies are required to use "plain English" in describing these risk factors, avoiding overly technical jargon that would be difficult for a layperson to follow.
Item 1B. Unresolved Staff Comments
The "staff" this is referring to is the SEC, not employees of the company, and it deals with anything that SEC staff finds inaccurate, incomplete, or otherwise not within reporting guidelines.
Item 2. Properties
This is where the company describes its physical real estate, usually both owned or long-term leases. There are specific regulations that describe what a company must disclose here.
Item 3. Legal Proceedings
Relatively self-descriptive, but a company isn't required to list every single legal proceeding it may be dealing with. However, if there is pending legal action that could have a serious material impact on the company, it should definitely be described here.
Item 4. Mine Safety Disclosures
This, of course, is typically left blank, with the notable exception of companies with mining operations.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
In this section, the company will list its stock high and low price for the prior several quarters, as well as its dividend policy, and recent stock buybacks or stock sales. The company will often also include a chart showing the performance of its stock against an appropriate benchmark index, like the S&P 500 for a large, stable company, or the Russell 2000 Growth Index for a smaller company with growth plans.
Item 6. Selected Financial Data
This is where you get into the meat of the numbers. This is also audited financial data, meaning that a registered independent accountancy firm has reviewed the company's financial reports. While this isn't a promise of perfection, there have been a number of laws enacted during the past decade that have added some serious teeth. For executives who sign off on these reports, primarily the CEO and CFO, the legal consequences are up to and including jail time for misleading, inaccurate, or intentionally falsifying these filings.
Typically, a company will provide historical comparisons of as many as the five prior years in this section, making it much easier to measure a company's more recent performance against the past without having to have a stack of filings spread out on the kitchen table.
This financial data includes sales and operations results, as well as the company's balance sheet.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
If Item 1 is where management describes what the business is supposed to be, then Item 7 is where they describe what the actual results are. There will usually be some key points of data highlighted, so it's important to review these things, looking for the bigger picture trends. It's also important to not take on complete faith that these selected points are the only thing that matter.
Analyzing a company's sales results, operations expenses, and its financial condition is as much about looking for what could go wrong as it is about what should go right. Identifying things like a weakening cash position, shrinking gross margin, or rising operations costs without appropriate sales growth, are the kinds of things that you can identify in this segment of the 10-K
But don't ignore all the prose and get too caught up in the numbers. It's a very good habit to read what management has to say about the business. Look for trends. Do they tend to accomplish the things discussed, or do you see reasons why something didn't pan out?
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
This is another segment that discusses risks that a company is exposed to, but is usually more specific with regards to things like foreign exchange for a company with foreign operations, or commodity costs for a company that buys a lot of a certain commodity it uses in its business.
Item 8. Financial Statements and Supplementary Data
The financial statements in this section may or may not be audited. Again, audited is no guarantee of perfection or accuracy, but it's important to be aware of it. Typically, a company may use this section to show quarterly breakouts of sales, costs, operations expenses, and other financial performance metrics including profits (or losses). The information here can be detailed, as well, and it's often quite repetitive of what you may have seen already in Item 6 above.
However, this segment will often include all of a company's financial statements, and typically for as many as three to five years. These are usually broken down by balance sheet, operations, comprehensive income (or loss), stockholder's equity, cash flows, and notes. The notes can be very detailed, with descriptions of things like the company's debt instruments, lease obligations (which isn't debt but is a similar liability), the cost of stock-based compensation, tax expense, or almost any other area of financial concern you may have about a company.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
If a company's accounting firm finds issue with a company's reporting or disclosures, it would be noted here. This is very rare.
Item 9A. Controls and Procedures
This is where the CEO and CFO certify that the company's disclosure controls and procedures are effective.
Item 9B. Other Information
If a company has other material information that would typically be disclosed on a Form 8-K that has not been disclosed yet, it can do so in this section, and not have to file a Form 8K. A company is required to have reported all material information before the 10-K is filed, so this just makes it easy if there's any additional necessary disclosure before 10-K filing.
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions and Director Independence
Item 14. Principal Accounting Fees and Services
All of the items above are disclosures, and sometimes, they are not broken out in the 10-K, but may reference the company's proxy statement for the company's annual shareholder meeting. If that's the case, you'll want to find the DEF 14A, which is the Definitive Proxy Statement. This can typically be found (along with the 10-K) either on the "SEC Filings" page of the company's website, or on the SEC EDGAR search page.
Item 15. Exhibits and Financial Statement Schedules
Things may get repetitive to both Item 6 and Item 8 here, depending on how the company chooses to report information. The main reason this section exists is that this is where the CEO, CFO, and members of the board of directors sign off on the filing, and the CEO and CFO certify that the 10-K is accurate.
Getting to know the 10-K makes it easy to use and a valuable tool
Yes, I know there's a solid chance I've now put you to sleep, but don't let that keep you from taking the time to crack the cover on the 10-K from your largest investments. Company's tend to follow the same format as above, which is largely guided by the way the SEC has structured the form to begin with.
This means that, over time, it should be easy to figure out what you should focus on, and what you can ignore completely. And because a lot of what's in the 10-K gets repeated in multiple sections, that immediately reduces the number of pages you'll need to focus on.
The bottom line? If you really want to understand what you own, you owe it to yourself to understand this most important filing, and not just take for granted that what analysts and writers -- including those of us here at The Motley Fool -- are reporting is accurate or true.
It's your money and future on the line. The more you understand what you own, the less likely you'll be to make poor guesses based on what other people are saying.
G.I. Joe said it best: Knowing is half the battle.