I am absolutely embarrassed to admit I have never looked at a 10-K Annual Report. Granted that is not even near the top 1000 embarrassing things I have admitted or done in my life, but considering my job, my blog and my active investments it may be number 2,032. I was finally inspired to change that when I saw an article in Kiplinger’s this month titled “Make the Most of an Annual Report” by Nellie S. Huang. Ms. Haung provides 7 areas of the 10-K that a newbie like myself should focus on:
- Risk Factors
- Management’s discussion and analysis
- Income Statement
- Balance Sheet
- Notes to Financial Statements
- Auditor’s report
Like most mainstream personal finance magazines the piece doesn’t go all that deep but provided me with the push I needed to start learning about the subject. This is not to fault Ms. Huang there are probably entire courses taught on reading these reports.
What is a 10-K Report?
Probably should define what I am going to read and analyze! According to Investopedia a 10-K Report is:
A comprehensive summary report of a company’s performance that must be submitted annually to the Securities and Exchange Commission. Typically, the 10-K contains much more detail than the annual report. It includes information such as company history, organizational structure, equity, holdings, earnings per share, subsidiaries, etc.
Reading & Analyzing My First 10-K
What better 10-K to look at than one of my biggest single stock holdings? I bought my first share of Walgreen Company (WAG) back in 2011. Since I run a nerdy personal finance blog I can actually find the post that stated I was going to buy WAG in 2011. Looks like at the time WAG had:
- A P/E of 13.3
- Operating Margin of 5.4
- Yield of 2.67
- P/B of 2.1
- I bought 8 Shares for $261.86 or $32.73/share on 10/4/2011
- It seems i bought more on 11/01/2011, 11/09/2011 and 11/22/2011
Despite overpaying in commissions those 4 lots are all up over 80%. So while WAG makes over 10% of my current portfolio that amount is almost entirely unrealized gains. I also can safely say I wish I bought more! Notwithstanding my trip down memory lane lets take a look at Walgreen’s 10-K.
I couldn’t believe how easy it was to find! A simple google search led me to Walgreen’s investor page and from there all I had to do was find the newest one (10/21/2013). At 120+ pages it is not light reading, so for this post I am going to focus on just those areas that Ms. Huang pointed out above (and in a future post I will go deeper into the report).
This is not a blog post promoting or condemning Walgreens. In years and years of blogging, I have never done such a post and while I am currently employed in the capacity I am I will never write those posts. Instead, the information below should be just interesting information pulled from Walgreen’s 10-K while keeping in mind that I have never read one before (also another reason you should never listen to me lol).
Pulled from the 10-K:
Walgreen Co., together with its subsidiaries, operates the largest drugstore chain in the United States with net sales of $72.2 billion in the fiscal year ended August 31, 2013. We provide our customers with convenient, omnichannel access to consumer goods and services, pharmacy, and health and wellness services in communities across America. We offer our products and services through drugstores, as well as through mail, by telephone and online.
We sell prescription and non-prescription drugs as well as general merchandise, including household items, convenience and fresh foods, personal care, beauty care, photofinishing and candy. Our pharmacy, health and wellness services include retail, specialty, infusion and respiratory services, mail service, convenient care clinics and worksite health and wellness centers. These services help improve health outcomes for patients and manage costs for payers including employers, managed care organizations, health systems, pharmacy benefit
managers and the public sector. Our Take Care Health Systems subsidiary is a manager of worksite health and wellness centers and in-store convenient care clinics (Healthcare Clinic), with more than 700 locations throughout the United States.
Since August 2, 2012, we have held a 45% investment interest in Alliance Boots GmbH (Alliance Boots), a leading international pharmacy-led health and beauty group , which we account for using the equity method of accounting. Alliance Boots delivers a range of products and services to customers including pharmacy-led health and beauty retailing and pharmaceutical wholesaling and distribution. We also have the right, but not the obligation, to acquire the remaining 55% interest in Alliance Boots at any time during the period beginning February 2, 2015 and ending on August 2, 2015, as described under “Business Development” below.
Nothing too earth shattering, but what was interesting was in the next section titled “Business Development”
As of August 31, 2013, Walgreens operated 8,582 locations in 50 states, the District of Columbia, Guam and Puerto Rico. In 2013, the Company opened or acquired 350 locations for a net increase of 197 locations after relocations and closings. The USA Drug acquisition contributed 141 locations (70 net). Total locations do not include 398 Healthcare Clinics (formerly Take Care Clinics) that are operated primarily within our Walgreens locations or locations of unconsolidated partially owned entities such as Alliance Boots.
2% growth in the amount of stores is nothing to ignore and something I would have never known just looking at the “value” numbers like I do when building my dividend income portfolio.
As of August 2013, approximately 75% of the United States population lived within five miles of a Walgreens and an average of 6.2 million shoppers visited our stores daily in fiscal 2013. In addition to store traffic, our websites, including Walgreens.com and drugstore.com, received an average of approximately 54.3 million visits per month in fiscal 2013.
Wow. I am only on the first section, and the 10-K is going deep into what makes the company tick. Hint:
In fiscal 2013, fiscal 2012 and fiscal 2011, prescription drugs represented 63%, 63% and 65% of total sales, respectively, general merchandise represented 27%, 25% and 25% of total sales, respectively, and non-prescription drugs represented 10%, 12% and 10% of total sales, respectively.
The wealth information is amazing. I could see why Warren Buffett would devour these yearly reports before purchasing significant shares. Notwithstanding, if you are picking up a couple grand worth of a stock just getting through this portion alone (and we didn’t even talk risk yet) could create a paralysis by analysis situation.
9 pages of 10 font risks! Each of the bullets below included a paragraph or 6 providing a deeper insight (please note that this is obviously not a complete list):
- We derive a significant portion of our sales from prescription drug sales reimbursed by pharmacy benefit management companies
- Reductions in third party reimbursement levels, from private or government plans, for prescription drugs could reduce our
margin on pharmacy sales and could have a significant adverse effect on our profitability.
- Consolidation in the healthcare industry could adversely affect our business, financial condition and results of operations
- We plan to use a single wholesaler of branded and generic pharmaceutical drugs as our primary source of such products. A disruption in this relationship could adversely affect our business and financial results
- Our ability to grow our business may be constrained by our inability to find suitable new store locations at acceptable prices or by the expiration of our current leases
- Changes in the health care regulatory environment may adversely affect our business.
- We are involved in a number of legal proceedings and audits and, while we cannot predict the outcomes of such proceedings and other contingencies with certainty, some of these outcomes could adversely affect our business, financial condition and results of operations
Granted some of the risk factors were CYA sounding, while others were very scary to read! The two themes that went deep was Walgreen’s dependence on a leaving the status quo in terms of how prescriptions are filled, and the other issue that seems to be worrying the board has to do with their possible takeover of a British company. I would really have to read more 10-Ks to determine whether 9 pages of risk is normal (or, alternatively, read past WAG 10-K to determine if that is just how they do it).
Management’s discussion and analysis
This was included as an addendum. Not sure if that is the norm for these types of documents but it was referenced in the actual 10-K and then found on page 69. It may be me, but this section read as “look how good we did.” It would be my guess that this section in almost any company not ran by pessimists would read similarly.
One would have to read this section very carefully to read between the lines (i.e. we had growth, but you’d have to determine if that growth is slowing…then dig why it was slowing). To be fair, WAG’s reads much more honest and straightforward than listening to your average CEO on CNBC hyping up their company on squawk box.
The document highlighted many different metrics that probably means a lot to an analyst in determining their buy/hold/sell recommendation. To be honest other than the basics (operating margin, same stores, RX sales) they are lost on me because I am not sure what would be an acceptable range in terms of growth.
Thus far it seems that this section would be the most important if you can read it while keeping in mind that the people “writing” (or at least approving) this section are those that made the decisions they are trying to justify. This would be a very interesting section to read from a company that is on a downward trend.
I am sure weeks are spent in accounting 101 on the Income Statement but a lot of it can be self taught (obviously not all). In this particular case sales are up for WAG while cost of goods sold are down. So, that is a positive for shareholders!
Interestingly, Ms. Haung says in her article,
Focus on the trend in net earnings rather than earnings per share, in part because share buy-backs, which cut the number of outstanding shares can skew earnings per share and thus camouflage a drop in overall profits.
Seems opposite of what Warren Buffett talks about in his annual letters (of which I am up to the mid-80s). Granted, buy-backs could skew earnings but as long as they don’t turn around and sell treasury stock the next year it would seem that earnings per share would be a great thing to keep score. Look at me! reading my first and only 10-K and providing an opinion opposite of a financial journalist. I am ridiculous.
Same as above in terms of the topic.
However, looking at WAG in particular it can be seen that they picked up an additional $650,000,000(yes, $650million) in debt, which isn’t terrible since they added $2bil in assets.
I wonder if someone advanced out there was able to read a company like Enron’s Income Statement and Balance Sheet and was able to call shenanigans? Seems like it has to do with just how open the company decides to be.
Notes to Financial Statements
Ms. Huang describes this section as the insight as to how the company calculated the numbers above. I don’t know enough about corporate accounting to understand if a more advantageous method was used when another should have been.
I am not sure why this section is all that important. Every 10-K is likely to have an auditor back up what is said in the report, but what happens when the info provided is BS? Enron, Worldcom, etc., they all had auditors.
Conclusion about Reading my First 10-K
There is a lot of great information in these reports. I learned more about WAG then I ever needed to know! Currently, my dividend investment portfolio doesn’t use 10-K information as a factor, but that could change in future. My problem would be avoiding paralysis by analysis.