MarketWatch Article Follow-up: "4 Things Smart Investors Look For In Annual Reports"

Today I want to talk to you about why data quality is really important. Most investors don't realize how much work needs to go into doing real research. Most of the analysts, including those on Wall Street, are taking shortcuts. They're not reading the entire annual report. Last spring, my good buddy Chuck Jaffee over at MarketWatch— he's one of the top columnists on MarketWatch.com— called me up and said, David, give me a couple of the items that are important to take out of an annual report. I said, Chuck, I can't just rely on a couple because you never know if the one that you overlook could be the one that blows you up, and it's different every time. He said, look, we're talking about retail investors here, so I can't tell them to read the whole 10-K because it's just impossible. And that's true. It is impossible. I even hear my friends at the SEC and the FASB talk about how it's pretty much an impossible task. There's too many disclosures. And my response is, well, which one are we going to cut out? Because all of them are important. They may be important at different times for different companies, but if we choose to cut one out, then basically we're handicapping investors' ability to really understand the truth about profitability. And we don't want to do that. The thing you need to do is have access to tools or proprietary technology as we do to go through all these filings because it makes a huge difference. That's why my friends at the FASB and the SEC often look to the things we do research and my advice to figure out what the loopholes are and to avoid creating future loopholes. Let me give you some examples of why this matters. In 2011, we wrote an article, Dead Company Walking, talking about Eastman Kodak, because we found one super important data point that blew the company up. It was on page something 85 or 285 of the annual report, I don't remember which one, but it was the expected return on plan assets for the company's pension plan. It was at 8.7%, bigger than just about any company that we covered by a significant margin, and a rather large return assumption considering that a considerable amount of the pension's assets were not all in equities. They were in lower-returning assets such as bonds and fixed income, which as we know have been very low for a long time in terms of rates. And what this high return on plan asset assumption allowed them to do is boost their revenues By 2.2%, revenues by 2.2%. All the while, the pension fund was underfunded by $3.6 billion, or something like 3 times the company's market cap at the time. That's cooking the books, and that allowed the company to report positive and growing accounting earnings even though the economic earnings were going down the tubes. And we pointed that out, and lo and behold, 6 or 9 months later, the company's pretty much bankrupt. The stock's down 90%. Another example where data made a big difference: Scripps Networks International— Interactive, I'm sorry. A report we did early last year as well pointing out that the company's economic earnings were actually much better than the accounting earnings because of the work we did in the footnotes. Another big item was the deferred content cost for Netflix. You look at how fast that's growing compared to actual revenues and you see that the cost structure of that business is really getting blown up. That stock's down a lot since we recommended investors avoid that as well. Sometimes it's not just one data point, it's a collection of multiple data points. Western Digital is a great example. That was a stock we made a buy recommendation on a couple years ago where we saw a lot of great things, and that one's done extremely well. I mean, it's up 50%, 100%, something huge. Another one like that is Viacom. You know, this was a lot of stuff in the footnotes, but in addition to that This company was doing huge buybacks, something like a 17%, the equivalent of a 17% dividend yield in the form of buybacks. That's a very strong data point. My point is, if you really wanna be diligent about your investing, you gotta look at all these things, 'cause you never know which one of them could completely support your thesis or deny your thesis. There's no substitute for doing the homework, otherwise you could get blown up. And that's a big difference between the things we do and what our competitors do. We really kind of have— we're a unique business that we have 2 different sort of competitors. We've got research firms that actually try to do what we do, and then there are the raw data providers. We're the only firm that collects our own data and does our own research, and I believe that makes us better at both. We know what data is important to collect because we're building our own models, and we also are smarter about our models because we know what data is available. Our competitors on the research side, most of those guys haven't looked at a 10-K in probably 10 or 15 years. I mean, haven't looked at one. They're completely dependent on the data providers. And when we run data checks or comparisons against other data providers, we blow them away. It's not even close. Sometimes a couple firms will get close on the income statement with a few companies here and there, but when it comes to the balance sheet, nobody's even close to the adjustments we make. And balance sheets matter. That's exactly what's blown up Amazon this year. As we've seen its cost structure completely change, not so much on the income statement side, but on the balance sheet side, where the capital returns in that business have gone way, way down. We've got a ton of data on this front. We've been making these adjustments and doing this kind of work on filings going all the way back to 1998. Nobody has a better database. We publish all of our adjustments as well. We want to challenge our competitors to to do as much diligence as we do. In my blog post that highlights the 30+ adjustments we make to get the truth about earnings and valuation, I go in extreme detail as to every single one of the adjustments we make. And I welcome you, our clients and our competitors, go out there, go make those adjustments. Try it for a company or two and you'll realize what a Herculean, what a humongous task it is. That's why I built a company to focus on creating technology expertise and intelligence around doing this with scale. That is why I'm called upon by FASB and other regulators to help advise them as to what companies are doing, where the loopholes are, where the bodies are buried, and how to fix it. So we encourage our clients to take advantage of the best ratings and the best fundamental research in the world on the 3,000+ stocks we cover.