Financial statements course · Lesson 10 of 10
Ten checks turn a 10-K into a short list of questions.
You do not need to read all of a 10-K. You need ten figures, the notes behind them, and the questions that they raise.
EDUCATION, NOT ADVICE ·
The example company. Example Co. is a made-up company, the same one as in the valuation course. A model script calculates every figure, so you can check each one. The method works the same way on a real company.
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The order
- Read Item 1. Write one sentence on how the company makes money.
- Read the three statements in Item 8. Check the five links from lesson 5.
- Calculate the ten checks below for the last three years.
- Read the notes behind each check that looks wrong.
- Read Item 7 and Item 1A. Compare what management says with what you found.
The ten checks
| # | Check | Example Co. | What to look for |
|---|---|---|---|
| 1 | Revenue growth | 8.0% | Compare with earlier years |
| 2 | Gross and operating margin | 45.0% / 18.0% | A falling margin |
| 3 | Cash from operations per $1 of net income | $1.35 | Below $1 for several years |
| 4 | Free cash flow | $105.1 million | Below zero, with no plan |
| 5 | Receivable and inventory days | 44 / 60 | Days that rise |
| 6 | Capex against depreciation | 2.0x | Below 1 for many years |
| 7 | Stock pay against revenue | 1.5% | A high or rising share |
| 8 | Change in share count | -0.5% | A count that rises |
| 9 | Net debt against EBITDA | 0.45x | A high ratio |
| 10 | Operating income against interest | 15.0x | A low ratio |
On one year of figures, Example Co. passes each check. Its cash follows its profit, its days are steady, and its debt is low. That makes it a good business. It does not make it a good price.
The next step: value
The statements show what the business is. They do not show what it is worth. At $30 a share, Example Co. trades above the value of $23.92 that the valuation course calculates.
The valuation course starts from these same statements. It turns them into owner earnings, returns on capital and a value per share. Take it next.
Key points
- Read Item 1, then the statements, then the notes, then Item 7.
- Ten checks, over three years, give you the questions to ask.
- A good business and a good price are two different questions.