There are stories—probably apocryphal—that Warren Buffett reads one annual report each day. That's a wise idea. There is a lot of useful information contained in annual reports, but one a day may be ambitious for the everyday investor.
Still, Barron's suspects that not enough investors regularly read annual reports, filed with the Securities and Exchange Commission on a form called the 10-K. Perhaps it's because investors think the reports are too daunting, or too boring.
General Electric 's (GE) annual report is 317 pages, American International Group 's (AIG) recent 10-K filing is 405 pages long. But getting through the reports isn't as hard as you might think. Here's how to read an annual report in 10 minutes or less.
Get some coffee
For this exercise, we selected one of Barron'srecent stock picks— Teradyne (TER). Its annual report was filed on March 1 and is a mere 154 pages.
Why did we pick Teradyne? It isn't the most complicated company in the world. It has a few different divisions, but it makes stuff—physical things it sells to other people. Companies that sell financial products or have many disparate divisions are a lesson for another day.
Teradyne is also a technology company and its products aren't for consumers. It sells to companies that sell to other companies that finally sell to companies that make consumer goods. Companies like Teradyne that are technology-laden and deep in the supply chain can appear difficult to understand. That doesn't have to be the case.
All 10-K filings are laid out in a similar way. The sections are set by the SEC. There is a business description, risk factors, mine-safety disclosures (Yes, mine safety disclosures are required for everyone.) and, eventually, financial statements. We will start with the business description.
Start the timer
Teradyne's business description is about 700 words, and it tells us that the company makes semiconductor-testing equipment. It sells that equipment to large semiconductor companies and got into the robotics business recently through two acquisitions.
That's enough to know. We're off to a quick start.
The business description can offer bonus tidbits, but you just have to scan it. It's helpful to search—assuming you are reading the document digitally—for "competitor" or "competition." Searching for terms is a good way to save time and we only have 10 minutes.
Teradyne does an excellent job listing its competitors. In less than a minute, we learn the names of many companies that can affect Teradyne's performance. The company, for instance, competes with Japanese equipment maker Advantest (ATEYY), as well as Keysight (KEYS). Checking on these two, we learn that Keysight is much larger than Teradyne. In the robotics business, Teradyne has a different set of competitors, again much larger, including the Japanese firm Fanuc (FANUY) and ABB (ABB), the Swiss conglomerate.
Now it's time to move on to the risk section and read the headlines. Before you sell everything, please realize that all companies list many risk factors. They need to cover their legal bases. Teradyne lists 27 or so risks. Some are generic, but quickly scanning this section we learn about tariffs—a topic in the news these days—and intellectual property, which usually matters to tech firms.
Grab the calculator
Now it's time for the financial statements. That means we have skipped 20-plus pages, including the mine disclosures. Is that a good idea? It's not ideal, but the goal is to extract the most value in 10 minutes, so we dive into the numbers next.
First up is the balance sheet, a snapshot of all the stuff Teradyne owns, expressed in language only an accountant could love. Companies usually provide two years of data. Note the total assets, in this case, $2.7 billion. Then look for cash and debt. Teradyne has about $900 million in cash and $400 million in debt. More cash than debt is a good thing. We can conclude that Teradyne's balance sheet is in good shape.
Next comes the income statement. It's good to power on the calculator at this point—or open a number-crunching app. Aggressive mathematicians can eyeball the figures.
In the income statement, we quickly check on growth, margins, and earnings. At Teradyne, sales have gone from $1.7 billion in 2016 to $2.1 billion in 2018. That's about 25% growth, but it includes acquisitions. The business was flat from 2017 to 2018.
Gross profit in the last two years was $1.2 billion, which means gross margins were stable for two years. The company lost money in 2016, but they had $330 million in goodwill impairments. That's not great, but you can exclude it when looking at average earnings. Teradyne earned about $450 million in 2018 and $330 million on average each year for the past three years (excluding the write-off).
Teradyne's equity-market value is $6.8 billion, so a glance at the calculator shows us the company is trading for about 15 times 2018 earnings and about 20 times average earnings. Usually, Wall Street values companies relative to their forward earnings, but tomorrow's profitability is linked to the past.
The last of the financial statement in our quick process is the cash-flow statement. Retained earnings is for another day.
Here, we do with cash from operations what we did with earnings. The company generated $480 million in cash from operations in 2018 and about $522 million on average each year for the past three years.
Just one line below cash from operations is capital spending: outlays to replenish the gear and facilities Teradyne needs to make the stuff it sells. That's about $100 million a year on average. If we take capital spending away from cash from operations, we learn that Teradyne generates about $420 million in free cash flow each year.
That's the money Teradyne can use to pay dividends, pay down debt, buy companies, or buy back its own stock.
The $420 million of free cash gives Teradyne has a free-cash-flow yield of 6%. That's free cash flow divided by the company's equity-market value. At 6%, Teradyne's yield is about 1 percentage point better than for the S&P 500 (.SPX).
There are still 90 second left. Ample time to read the notes to the financial statements. We treat these like the risk section. Read the headlines and stop if something strikes your fancy.
I like to look at the retirement plans. The company's pension-plan promises amount to $178 million—2.6% of Teradyne's market value. Not a big deal, and Teradyne has $144 million set aside to pay the obligations.
The most important note is often the business-segment detail. Here we learn that Teradyne's semiconductor-test business is its largest segment and that sales in that operation shrank in 2018. Industrial automation, on the other hand, is small but growing rapidly. What's more, margins in the robots division are small, at about 3%. That's something to watch: Ideally, as the automation business grows, higher margins will follow.
(Looking for divisions that are losing money is a good way to find hidden value that can generate investment returns in the future.)
That's it. We are done.
What did we learn? Teradyne is a smaller tech supplier with a good balance sheet and stable margins, trading at a slight discount to the S&P 500 based on both its price/earnings ratio and free cash flow. The robot business is growing quickly and has just become profitable. Also, tariffs are a concern and the business is cyclical.
With all this, you could write a Wall Street research report.
You can spend as much time as you want poring over filings. Barron's thinks any amount of time spent learning about a company is a good idea. The knowledge picked up doesn't fade. It compounds.
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