A basic principle of solid fundamental analysis is striving to find out everything one can about the stock issuer's business. Good analysts and investors search for all material information about a company before starting to do a company analysis project. Gathering information about a company is like turning over all the pieces of a jigsaw puzzle before starting to search for matching pieces. In this article, we'll show you which pieces to look for and how to put them together in order to learn the most about a company.
In the United States, investors are fortunate to have a relatively standardized flow of information from equity issuers. The Securities and Exchange Commission (SEC) has a comprehensive set of rules covering everything from financial statement rules to risk factor disclosure. The SEC also says what companies must present to investors and when they have to do it. For the most part, investors know what to expect and when to expect it.
In the equity investment business, the world tends to revolve around quarterly earnings releases. Four times per year, equity investors deal with earnings season - those few busy weeks every quarter when companies release their quarterly earnings reports. The way companies report earnings varies a lot from company to company and industry to industry. Quarterly earnings announcements generally include unaudited financial statements, discussions about business conditions for the quarter and some type of future business outlook. Some earnings reports are a couple of paragraphs and an income statement. Other reports are full discussions of business conditions and expectations, along with a full set of financial statements.
Earnings releases are important disclosures of financial information and business conditions because they are timely, even though they are often incomplete. Investors usually have enough information in an earnings release to see how well a company met earnings expectations and how close management's financial outlook matches their own. That's key when reviewing the status of a stock you already own. Reviewing historical earnings releases is also important in building a thesis on a stock you are considering for purchase, because they help give the investor a sense of the progress of management's business plan as well as management's approach to disclosing financial results.
Most companies also hold an investor conference call on the day of their quarterly earnings releases. Companies typically archive recordings of these on their investor relations websites. Conference calls vary considerably from company to company in terms of disclosure. The purpose of conference calls is to add detail to the earnings release and give analysts the opportunity to ask management questions. Conference calls can be important sources of information about management's outlook for a business. This outlook is commonly known as guidance.
Guidance is management's prediction for business for the next quarter, several quarters, the fiscal year or several fiscal years. Depending on the company, forward guidance can vary from a full range of revenue and earnings growth rates to simple earnings per share predictions. Some companies give no guidance at all, while others just say they are comfortable with Wall Street predictions.
Investors must be aware of management's outlook and must also be aware of how well management has done with its earnings predictions in the past. While definitely not the only source of information for making predictions, guidance is important in building a set of financial expectations for a company. Examining the trend in historical guidance and how well results matched the reported forecasts can provide a sense of management's understanding of where the company is headed. One can also get a feel for management's conservatism in giving guidance – regardless of whether management tends to "low ball" Wall Street in order to generate positive earnings surprises.
Every U.S. company must generate four standardized financial reports for public dissemination every year: three quarterly 10-Q reports and one annual 10-K filing. Form 10s elaborate on earnings reports, providing more full disclosures like management's discussion and analysis (MD&A) of financial results. MD&A is a more complete disclosure of business performance during the quarter or year than would commonly be found in an earnings press release.
Form 10s always include a full set of financial statements - unaudited statements for the quarterlies and audited for the annual filing. Audited financials are audited for their adherence to generally accepted accounting principles (GAAP). Unlike earnings announcements, Form 10s are not timely and they always come out at least a few days or weeks after an earnings announcement. Historical Form 10s are the primary source for financial and business information when building a thesis on a new stock.
Press Releases and Investor Presentations
Companies commonly issue non-earnings-related press releases on business developments throughout the year. These cover anything and everything. Companies must report material business developments to the public as events arise. So every new business contract, acquisition or divestiture, change in management or anything else, is disseminated to the public on an ad hoc basis via press release.
Press releases are also the avenue through which companies disseminate earnings warnings. When management becomes aware that the company's financial performance for a quarter is not tracking Wall Street's expectations or its guidance, they will disseminate a press release stating this. The idea is to get material information that could affect a stock's price in the market out to the public as soon as possible. Bad financial news is often released well ahead of actual earnings releases.
Many companies include special presentations on the investor relations pages of their websites. These are usually intended to help investors understand the business and management's approach to running it. They can be an important place to start looking at the fundamentals of the business, as they often explain key business drivers, industry exposures and non-financial fundamental business drivers.
Management often delivers these presentations at institutional investor conferences put on by sell-side firms. These conferences are typically held a few times per year in big cities throughout the country. Institutional investors have to be invited in order to attend these conferences, requiring ample trading business. Conferences are typically not open to the public, even though investors can usually get a copy of the presentation's slides from the investor relations page.
The Bottom Line
Equity investors must always remember that the management teams of public companies are the most biased market participants out there. In fact, most company CEOs think their stock is a great investment opportunity. The SEC's disclosure rules help provide unbiased information. Any other color provided by management - like in an investor presentation, face-to-face meeting or interview on television - is bound to put the company in the most optimistic light possible.
Before starting to build an investment thesis on a stock, investors should put their printer to work. Most company analysis files will have at least one 10-K report, several 10-Q reports, a big stack of press releases and hard copies of investor presentations. Once an analyst or investor gets a good base of knowledge from doing this reading, he or she can then move on to building a financial model and conducting the financial and business analysis necessary to develop a good investment thesis on a stock.
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