Reading Form 10-K: Unveiling the business secrets of the enterprise

Talking about his successful investment secrets, Warren Buffet shares:

One of the main documents Buffet reads is the 10-K Report (Form 10-K). According to Buffet, the 10-K report is where businesses showcase their inner strength, beyond glossy PR materials.

Form 10-K is a comprehensive annual report filed by publicly listed companies, as required by the U.S. Securities and Exchange Commission (SEC).

This is an extremely useful document for Fundamental analysis of a stock and business from both hard aspects (metrics and financial reports) as well as soft aspects (the business's potential from management to business direction).

In this article, Việt Hustle will help readers understand the structure, key sections to note in the 10-K reports of companies, illustrated specifically with the Apple example.

The importance of the 10-K report

Investing in a company without reviewing their 10-K report is like trying to solve a complex puzzle without the illustration.

Form 10-K is a treasure trove of in-depth information for investors, including:

• Revealing the big picture: 10-K provides a full view of the company's financial situation over 1 year, including:

  • Overview of the market and business operations

  • Audited financial statements

• In-depth information on risks and strategies: Section 'Risk Factors' and 'Management's Discussion and Analysis' (MD&A) provides investors with a candid view of the company's risks, challenges, and opportunities.

Structure of the 10-K report

The typical structure of 10-K usually consists of 3 parts:

1. PART I: Business situation and risk factors.

2. PART II: Management's financial report and analysis

3. PART III: Compensation and share ownership ratios of the management

Part 1. Business situation and risk factors.

1. Business situation

Provides a comprehensive view of the company's main business activities, including products and services, key markets and competitors in the industry.

Objective => Understand how the company generates revenue (important): business model, revenue structure, industry position, competitive advantages, and strategic direction of the company.

• Positive signs: Diverse product lines, large market share, clear growth strategy, differentiated competitive advantages

• Need to consider: If a business depends too heavily on one product or market, the industry tends to grow poorly, and business direction is unclear.

=> The nature of the business model determines the potential and durability of the business: must understand a business before considering investment:

1. Is revenue stable?

2. Is it concentrated in one segment or geographic area?

3. Does revenue depend on a few large contracts or small transactions?

4. What types of costs are needed to sustain revenue growth rate?

5. Does the company have competitive advantages (patents, intellectual property…)?

Example with Apple:

• Apple has many product lines but iPhone generates the majority of revenue (67% of 2023 revenue).

• Apple's Services segment includes: advertising, AppleCare, Cloud and Apple Pay

• Apple is primarily managed on a geographic basis: 37% of net revenue comes from direct distribution channels (company's own retail stores and online).

2. Risk factors

This section outlines the company's risks and challenges across aspects: business operations, financial, legal or market...

=> Helps investors evaluate the company's potential vulnerabilities and how they may impact future performance.

Objective => comprehensively identify potential risks related to business operations, financial condition, and the industry in general:

• Positive signs: If the risk assessment is honest and detailed with clear mitigation plans, demonstrating management's proactivity.

• Notable: Generic risk descriptions, ignoring industry-specific threats, overly optimistic outlook.

Example with Apple

The types of risks listed by Apple in its 2023 10-K report include:

• Macro and industry risks:

  • Global economic outlook, changing market trends, and technological advancements affecting Apple's industry position and revenue.

• Business risks:

  • Operational challenges such as manufacturing, supply chain, product quality, and dependence on key personnel.

• Legal and regulatory risks:

  • Legal proceedings, intellectual property issues, changes in laws and tax regulations, as well as privacy requirements.

• Financial risks:

  • Aspects such as exchange rate fluctuations, credit and liquidity risks, as well as other financial management factors.

• General risks:

  • Other factors such as environment, natural disasters, or global disruptions.

Part 2. Management's financial report and analysis

3. Financial statements

Includes the company's audited financial statements previously summarized by Viet Hustler, which readers can review at the link below (including Apple example)

1. Balance sheet: Notes on Assets and liabilities,

2. Income statement: Revenue, expenses, profit

3. Cash Flow Statement: In which items has cash come in and out?

Objective => Review trends in revenue, profit, debt, and asset management efficiency.

• Positive signs: Sustainable revenue growth, stable or improving profit margins, manageable debt, efficient asset utilization.

• Notable: Erratic revenue increases and decreases, declining profit margins, rising debt, poor return on assets.

4. Management's Discussion and Analysis (MD&A)

Management's analysis of financial results and operations will be

• an explanation of the story behind the numbers in the financial statements,

• revealing management's strategy, future prospects, and key business areas.

Objective => Management's analysis of past performance, future prospects and proposed strategies

• Positive signs: Clear correlation between strategy and results, future direction, acknowledgment of challenges and plans to address them.

• Notable: Discrepancies between management report and financial results, overly aggressive growth forecasts, lack of clarity in strategy execution.

Example: Apple provides detailed information on its product lines, expected future figures, and explanations of business performance:

Why did iPhone sales decline in fiscal year 2023?

Management explains that revenue improvement from iPhone Pro models could not fully offset the revenue decline from non-Pro iPhone models.

5. Notes to the Financial Statements

These notes provide important additional details for the financial statements:

• For example: accounting methods, provisions, disputes, and detailed analysis of financial items.

Objective => Review Accounting policies, revenue recognition methods, notes on revenue/expense recognition

• Positive signs: Consistent application of accounting principles, transparent revenue recognition methods, and reasonable financial obligations.

• Notable: Frequent changes in accounting methods, unclear revenue recognition, large off-balance sheet debt.

Part 3. Executive compensation and equity ownership

6. Executive Compensation

This section discloses pay for the company's top executives.

• Good compensation plans encourage management to create long-term value for the business

Objective => Alignment between executive pay and company performance; Incentive structures promoting long-term growth.

• Positive signs: Performance-based compensation, reasonable pay relative to industry standards.

• Notable: Excessively high pay unrelated to performance, complex compensation packages lacking clear incentives.

7. Auditor's Report

The audit independently evaluates the company's financial statements.

• Any concerns raised by the auditors may be warning signs about the company's financial operations.

Objective => Auditor's opinion on accuracy and transparency in the financial statements of the company.

• Positive signs: Unqualified opinion indicates reliable financial statements.

• Notable: Disclaimer opinion or Adverse opinion

How to read and analyze a company's 10-K report

After understanding what a 10-K report includes, investors can apply some useful tips to analyze the 10-K report effectively:

1. Start with a specific purpose: Know what you're looking for!

   • Are you evaluating the financial situation, growth potential, or management effectiveness of the company?

2. Compare and contrast:

   • Historical comparison: Is revenue growing? Is debt becoming more manageable?

     => Helps identify the company's business trends and patterns.

   • Compare with industry benchmarks: Comparing with peers in the same industry reveals strengths and weaknesses relative to competitors and provides an overview of the market.

3. Understand the picture behind the numbers:

   • Business model: what's important after the numbers is to understand how the company makes money, competitive advantages and growth strategy of the company.

   • Non-financial factors: External factors such as changes in laws, market trends, and technological advancements can impact the company's future.

4. Use metrics wisely:

   • Financial metrics: Use key financial ratios as analysis tools.

     • Read more: Metrics in financial analysis - Fundamental Analysis

   • Compare with the industry: Metrics can vary significantly between industries.

     => Compare with industry standards to know the company's position.

Conclusion

In summary, 3 key points that Việt Hustle wants to convey to readers when analyzing a company's Form 10-K:

• The 10-K report provides a comprehensive view of the business model, risks, financial health, and management strategy of the company.

• The numbers in the financial statements are just a small part => What's important is the picture behind them, shown through MD&A and risk disclosure sections.

• Some tips for analyzing 10-K reports such as: determining a specific purpose, comparing with history and industry, using financial metrics,…

The 10-K report is a long document containing a lot of information and often intimidates investors when reading and analyzing it. With the above article, Việt Hustle hopes to help readers analyze the 10-K report more easily to make wise and informed investment decisions.