How to read a 10-K properly, in about forty minutes

Nobody reads a 10-K front to back. The document is written to satisfy a disclosure regime, not to be read, and roughly ninety per cent of it is carried forward unchanged from last year. The value is concentrated in the parts that were rewritten, and finding those is a mechanical task before it is an analytical one.

Read it in this order

1. The cash flow statement, first

Start at the back. Cash flow from operations is the hardest line in the document to dress up, and the gap between it and reported net income tells you most of what you need to know about earnings quality. Then look at capital expenditure against depreciation: a company spending well under its depreciation charge for several years is shrinking its asset base whatever the income statement says.

2. Management discussion and analysis, current year only

Item 7 is where management explains the numbers in their own words. Read this year against last year and pay attention to what has been added and what has quietly gone. A metric that management highlighted for three years and then stopped mentioning has almost always stopped being flattering.

3. Risk factors, changes only

Item 1A is largely legal boilerplate and most of it is identical to last year. What matters is the delta. A newly added risk factor is a statement that the company's lawyers now think something is probable enough to disclose, and that is genuine information. A risk factor that has been reworded is worth reading twice.

4. The notes, specifically these ones

• Revenue recognition, if the business has anything resembling a contract
• Segment disclosure, which is the only place the real business mix appears
• Debt maturities, which is where a refinancing problem shows up two years early
• Leases, because post-ASC-842 the operating lease obligation sits in a caption many screens do not read
• Share-based compensation, against operating cash flow rather than against net income

The four comparisons that do most of the work

1. 01This year's MD&A against last year's, side by side.
2. 02Segment revenue growth against total revenue growth. Divergence is the whole story in a conglomerate.
3. 03Operating cash flow against net income, over five years rather than one.
4. 04Reported operating margin against a margin recalculated with share-based compensation treated as a real cost, because it is one.

What forty minutes actually buys

Not a view. A map: what the business earns, where the cash goes, what the company itself thinks could go wrong, and which two or three numbers a thesis would have to hang on. That is the point at which building a model stops being data entry and starts being analysis.