In this article, I will show you how to read and analyze any 10-K annual report in a time-efficient and productive manner. It is vital that stock market investors and analysts know how to efficiently read a 10-K annual report, as it's the best way to really get an in-depth understanding of a business.
Although it may seem daunting and extremely time consuming to read through an annual report, as many are around 150 pages, as an investor, you don't have to read through every single section. In many cases, reading though an entire annual report is a waste of time and will not provide you with much of an advantage.
Therefore, in this article, I will discuss the most important sections in a 10-K annual report that require reading and will cover what I'm looking for in each.
How to Find 10-K Annual Reports
To find the annual reports of any publicly traded company, simply search the company name along with "investor relations" into Google and there should be an investor relations page for the company you're looking at.
Note that a company's website may not have an "annual reports" page, they may only have a "SEC fillings" page, particularly if it's an American company. On this page, you should look for the "10-K" name as it is the filing type for an annual report.
You can also use the SEC's website itself to search for company filings. After you've selected the right company, select "10-K (annual reports) and 10-Q (quarterly reports)," then click on "View all 10-Ks and 10-Qs." There, you can find the 10-K filing for the year you want to analyze.
For the purposes of this article, I will be covering the most recent 10-K filing for Advanced Micro Devices (AMD), filed on February 4, 2020. AMD is a multinational semiconductor company. The company is widely known for its computer processors and graphics cards.
The Cover Page and Table of Contents
After you open or download the 10-K report, you will see a cover page with legal and company information. Below this first page, you will see an Index or Table of Contents.
As you can see, AMD's 10-K annual report for the fiscal year ended December 28, 2019, is 90 pages long. Typically, the more complicated and larger a business is, the lengthier its annual reports will be.
As mentioned before, reading through an entire annual report would only be a waste of time, so it's best to just focus on the most important sections. Afterwards, you can decide on whether you want to look further into a company, and perhaps even read more of the 10-K annual report. Regardless, these sections are discussed below.
The first section you will notice after the table of contents is "Business." This section basically includes all of the information about a particular business, and can be referred to as the business summary.
Information in this section may include (but is not limited to):
- How the business generates revenue.
- What and where it spends its money on.
- Its marketing strategy.
- Its distribution process.
- Any major competitors it may have.
This is a section that you want to read through completely at least once. Ensure that you understand all of the different components of the business and how it operates.
I wouldn't recommend reading through this section for previous 10-K annual reports. For the most part, it's going to be very similar. However, I would quickly glance at previous business summary sections on 10-K annual reports, going back at least 10 years. Again, you do not have to read every previous-year business summary section completely, but you should definitely have a glance to see how figures have changed and how they have impacted the business.
Over a 10-year period, businesses tend to change their operations, so it's important to understand what those changes were and why they happened. For example, for AMD, one thing I would look at would be AMD's competitor analysis, how their strategy has changed from 5 or 10 years prior, and to understand what AMD is doing as of now to continue growing its industry market share.
If you read through a business summary and still do not understand the business model or how the company operates, it's probably best to select a different company for analysis. This confusion may be due to management poorly explaining the business, or the industry simply being too complicated for an outside investor to understand it.
The second section, risk factors, follows directly after the business summary section. This is a section where management describes all of the risks that are associated with an investment. Therefore, this is an extremely important section to read through and understand, as these are the factors that may prevent your company from providing you the returns that you want.
For example, AMD's risk factors are described below:
Typically, when you make an investment in a company, you have certain goals in mind that you hope they're able to meet, including profitability goals, cash flow goals, customer growth goals, and more. These risks can therefore prevent your investment from generating higher returns, which is why you should thoroughly read and understand all of these risks. In general, you only need to read through these risks for the most recent annual report, as it will not change dramatically year-over-year when you're looking at past annual reports, much like the business summary.
Although understanding the risks of a company is crucial, the risk factors section is often times written by lawyers who are more concerned with avoiding lawsuits than providing enlightening information to investors. Keep this in mind when you read the risk factors section, as some parts are not particularly insightful, such as "our stock price is subject to volatility."
Selected Financial Data
The next section I would read through is the "selected financial data" or "selected consolidated financial data" section. I don't always look through this section, but it can be a good place to get a sense of factors such as revenue, earnings growth, and debt management. It's also a good place to quickly source raw data figures, which you can then use for your analysis or spreadsheets.
In many cases, this section presents selected data for the past five years. You can either use the selected financial data from the 10-K annual report, or use a site such as QuickFS to source a company's raw data. However, you should always double-check the numbers you receive from third-party providers to ensure that the numbers line up with those from the official financial statements.
For the selected financial data section, you may want to look at and analyze the "net revenue", "diluted earnings per share", and "total assets" rows over the five-year period. The best way to view this information, however, is to take notes on figures that seem out of place, which you should then later research after reading through the 10-K annual report sections provided in this article. For example, if net revenue failed to grow one year, I would attempt to find why this was the case.
Again, this is a section I do not spend too much time on, as the full financial statements later on in the 10-K annual report provides us with more information and raw data to work with.
Management's Discussion and Analysis (MD&A)
The next important section is directly after the selected financial data section. The "management's discussion and analysis of financial condition and results of operations" or just "management's discussion and analysis" (MD&A) for short, is one of the most important parts of the annual report.
This section provides investors with information on what drove the success or failure of the business during the year. It also tells readers about how their performance compared to last year and the year before that. In other words, a three year period. This section will often include snippets on what management's strategy is for growing profits for the business in the future.
One snippet from AMD's MD&A sections is below, which AMD's management team likely put together to help investors gain a better understanding of the company's cash position over the last three years:
Ultimately, this is the section that you should direct most of your attention to in an annual report. You should therefore read this section completely for multiple 10-K annual reports. If I were to seriously consider investing in a company long-term, I would read this section for every year, going back 10 years of annual fiscal years, to understand how management strategy has changed over time and to determine how or whether management has been successful with their strategies.
Although this section is important to read through, there is some redundancy you may notice from the business summary, which may be due to lawyers attempting to limit legal liability. Besides the redundancy you may read, MD&A readers should focus on parts where management explains the economics of the business and the results of operations over the past three years. Readers should also focus on any assumptions and estimates made and how they affect the financial statements.
For example, in the MD&A section, AMD discusses how their operating results vary seasonally and revenue is higher in the second half of the year than in the first half. They also discuss why their computing and graphics segment net revenue increased by 14%, mentioning increased demand in Ryzen processors.
Some of the factors you should think about when reading through an MD&A section include:
- What were the factors preventing growth in the business in the way that they expected?
- What limited or boosted profitability or margins in the way they did not expect?
- Do reductions in profitability happen often? If so, how often do they happen and what is the company doing to improve profitability?
The MD&A section is also a good place to get a grasp about what the key business indicators are. In other words, as investors, we need to identify the unique indicators that provide us with information on the performance of this particular business as compared to the industry standard. There are specific numbers in each industry that are driving the performance a business.
An example of this could be for a restaurant chain, under "key measures we use to evaluate our company" or a similar name, management would discuss measures they are using to determine whether or not they've been successful over a period or not. This may include the number of restaurant openings, comparable restaurant sales growth, average unit value (how much each restaurant generates in sales), store weeks open, and more.
Some companies, such as AMD, will not provide key measures as it may not be very relevant to its industry. Regardless, ensure that you read through and completely understand the MD&A section before investing in a business.
Financial Statements and Supplementary Data
The next major section is the official "financial statements and supplementary data" section. This includes different financial statements and any additional data, typically over a 3-year period.
These are the three financial statements you should focus your attention on:
For purposes of this article, I will assume that you know how to read and analyze each of the three financial statements, as this is a rather lengthy explanation, which can be understood by reading the articles linked above.
Similar to the "selected financial data" section on the 10-K annual report, this section is another good place to get all of the core numbers to fill out your analysis spreadsheet. This includes revenue, earnings per share, equity, and owners earnings, if you were attempting to value a company and its stock price.
Some of the other numbers you may need from these financial statements include debt numbers to calculate the return on invested capital (ROIC). You will also need liability and asset numbers to assess the debt levels within the company.
Notes to Consolidated Financial Statements
The section following the financial statements section is called the "notes to consolidated financial statements" (or something very similar). This section is basically a glossary of sorts for all of the terms used by management in the financial statements. This section also includes supplemental information to the financial statements, which help to explain certain line items more in detail (e.g., changes in depreciation).
This is a section I don't always read, at least in full. However, if I were to read through and analyze a line item on one of the financial statements and not completely understand what it meant, or where it came from, I would first look through the notes to consolidated financial statements before looking elsewhere.
For example, if I was curious on how a company spent its advertising budget for the most recent year, I would look for specific information on what the company does to market its products or services. This may include online or offline marketing, sponsorships, billboards, TV advertisements, and more. Although this information may also be found on the business summary and MD&A section, more detail and numbers may be found on the notes to consolidated financial statements sections. I would also question other aspects such as how the company recognizes revenue and whether it's at the point of sale or at some other time in the future.
Some parts in the notes to consolidated financial statements section are expanded extensively. For example, "share-based compensation" or "stock-based compensation" usually takes up a big chunk, where management discusses the different kinds of shares that are compensated to management when the business performs in a certain way.
If a company I'm analyzing has a large amount of debt, then I'd probably look closer into this section as well. Although I would probably avoid investing in this company, I may be interested in finding out when their debt is due and the specific interest payments for the debt. All of this information would be found in the "share-based compensation" or a similarly named section within the notes to consolidated financial statements.
The Bottom Line
From an investors perspective, the rest of the 10-K annual report is filled with information of little use, including lots of legal jargon and repetition. Therefore, as an investor, it's best to focus on the below sections:
- Business summary
- Risk factors
- Selected financial data
- Management discussion and analysis of financial condition and results of operation
- Financial statements and supplementary data
- Notes to consolidated financial statements
I am not suggesting that you avoid reading other sections on a 10-K annual report. What I am suggesting, however, is that you use the above sections to assess whether a company requires further study. Time is limited, so to best understand a company and come to a decision on whether a company is worthwhile investing in, I would recommend following the general guidelines taught in this article.
In the end, if you continue to practice reading through different annual reports of companies from different industries and sizes, you'll be able to make more informed and confident investment decisions. As you read through more and more 10-K annual reports, you'll also develop your own habits, areas of competencies, and will know what information to look for in the companies you're analyzing.