How to Read 10Ks Like a Hedge Fund

“Fundamentals don’t matter anymore!” I’ve heard this a lot lately on Fintwit.

But, for those who’ve diversify beyond $GME and $DOGE, here’s a primer on what metrics fundamental buy-side PMs look at and why:
(real examples outlined)

1/ Start @ business overview.

Look for these critical pts:
- market ecosystem (Who are the suppliers, distributors, partners? How is each $1 split btw the diff. players?)
- revenue model (How do they get paid? Subscription? Ads? Transaction fees?)
- product line/s (pure play?)

Reg flags if changes in:
- risk factors
- regulation

Why?
"If there’s a change here, it's b/c lawyers said so."

- if "cyber hack" gets added, there was probably a recent breach
- if "asbestos liability" gets added, expect workers comp to balloon

Useful tip:
If this is your 1st time ramping up on the company, read the business overview section whole.
If not, use a tool like FileMerge/opendiff to quickly find what’s changed since last year (hopefully, not much).
If you can't bash but got $20K to drop, get a Bloomberg.

2/ MD&A

Look for mgmt’s explanations on:
- revenue growth trends (if decelerating, why?)
- near-term expansion focus (selling up-market? geographical exp? partnerships? new product?)
- metrics that beat/missed
- competitive moat
- biggest risks
- governance changes
- guidance

3/ Financial Statements
aka the crux

Juiciest parts are in the FOOTNOTES (where truths like off-balance-sheet assets, operating leases, depreciation, etc. get uncovered).
But first let's start with the three statements (income statement, cash flow statement, & balance sheet).

3a/ Income Statement

Look for:
- revenue %YoY growth (lots of co's, esp. tech, trade on revenue multiples... gotta keep 'em high to maintain those valuations)
- margins (economies of scale says margins should improve)
- one-time expenses/ writeoffs
- discontinued ops

3b/ Cash Flows

Look for:
- changes in working capital or DSO (days sales outstanding) -- why? these 2 metrics indicate ST solvency
-rising accts receivable -- why? this is a sign of capital inefficiency & maybe deteriorating customer quality
-negative CFFO (from operations)

- CFFO < net income, consistently (sign of some earnings shenanigans... see https://bit.ly/3tuTBys )
- CFFI >> CFFO, consistently (can't mooch off investors forever!)
- using one-time sales to pay down debt
- capex < depreciation (mgmt is not investing back into biz)

3c/ Balance Sheet

Look for:
- Rising debt/equity (if >200%, usually sign of impending liquidity crunch)
- Falling interest coverage (if <5, usually sign that operating income can't cover ST interest)
- Big change in cash w/out corporate action
- High goodwill (aka bad will)

3d/ Footnotes: aka the fine print
DO NOT SKIP

Look for:
- revenue recognition explained
- GAAP vs non-GAAP (i.e. what did mgmt add/remove in Adjusted EBITDA?)
- off-balance sheet / VIEs
- operating leases
- legal actions
- LT debt maturities
- errors in previous filings

4/ Unresolved Staff Comments

Good case: this section is empty (about 99% of the time)

Trouble case: this is where mgmt addresses comments it received from the SEC on previously filed reports (had to dig a LONG AF time to find an example, Forrest Oil Corp -- now defunct)

5/ Executive Comp

Why should u care how the CEO gets paid?
- CEO's goal is to maximize his bonus, so make sure the executive incentive plan is aligned w/ long-term value

What metrics are execs most often comped on?
- #1 revenue (20.2% of the time)
- #2 EPS
- #3 operating income

2nd reason to look @ proxy statements: signs of corporate governance issues

e.g. Michael Eisner's reign @ $Disney
- Board was stacked w/ insiders (so nobody challenged Eisner, no checks & balances)
- Hired & fired Michael Ovitz after 14 mo. w/ $130M golden parachute

6/ Beneficial Ownership

Look for:
- high % ownership by insiders (C-suite, board): sign that mgmt is aligned w/ shareholders
- insider buying (Peter Lynch: "insiders might sell for a number of reasons, but they buy for only one: they think price will rise."
- insider sales

- if you see the CEO purge stock like a hot potato post-IPO, that's a clear-as-day sign that it's all over
e.g. #1 real news -- Tom Siebel @ $AI
e.g. #2 fake news -- @brian_armstrong sold 750K shares & apes thought he sold 75% of his stake...

Now this thread is over.