Want to know the risks of a company? Read the company’s footnotes in their 10Ks.
Has the company:
Has the company:
- Dipped into reserves for accounts receivable, the so-called bad-debt allowance, or factoring receivables?
- Lied about inventory costs to reduce apparent cost of goods sold?
- Extended the useful lives of property and equipment to reduce depreciation expenses? (Or is depreciation absent on income statement)?
- Carried a higher value for assets than they are worth?
- Exposed itself to impairment risk from excessive amounts of goodwill?
- Hid debt in accounts payable or other accrued liabilities through supply-chain finance?
- Borrowed short and lent long?
- Hid debt "off sheet" through variable interest entities?
- Recognized revenue before they have cash in hand, building up contract assets?
As Jason Zweig says in his commentary to The Intelligent Investor, be cautious of technical terms such as “capitalized,” “deferred,” and “restructuring”—terms that should raise the hair on the back of our necks. It doesn’t mean we don’t invest in companies that use these accounting methods, but we proceed with caution.
We must read the footnotes to know the truth behind the reported numbers on the financial sheets.
Otherwise, simply believing the numbers at face value is only fooling ourselves.