How to research a stock from scratch

Step by step approach to research a stock from scratch

Many of you might have heard others saying “Apple is a great company” or that “3M is risky as it has severe legal overhangs regarding its earplugs lawsuits.” You might be wondering to yourself: “How do I go about learning about such things about a particular company?” In this article, I will be sharing with you how I go about researching a company using free resources online that are available to everyone.

I like to think of this process as similar to solving a mystery; throughout the journey of researching the company, I am playing the role of a detective trying to uncover clues that will hopefully allow me to solve the case of the mysterious company at the end.

In today’s article, I will be using Adobe as an example. Curiously, I have never done a dive into the company before despite being familiar with its products so this would be my first time taking a closer look at the company.

Step 1: Identifying a company for investment

Usually, to find potential investment ideas, I would look to fire up a couple of online scanners that would return interesting companies based on my defined set of parameters (good revenue growth, reasonable debt levels, growing earnings, cash flows, etc.). My favorite free scanner is FinViz. You might like to check out this previously written article for a more detailed dive into how to use various online resources to seek new investment ideas:

Step 2: Go to the Source

After I have found an interesting company, I would usually look to find out more about the company by going straight to their website. In this case, I will simply google “Adobe IR” (IR: Investor Relations)

Step 3: Investor Presentation

On this page, you will be greeted by a treasure trove of information that is incredibly useful for investors that are interested in / invested in Adobe: Financial information, events and presentations, corporate leadership, and event FAQs about the company. Every company has an IR section on its webpage. For dividend-paying companies, there’s even useful information regarding the dividend (when is the dividend paid, dividend-paying history, an inbuilt calculator that tells you how much dividend you would receive over time with a number of owned shares, and their DRIP program).

After taking a cursory look at the main page of Adobe’s IR, I will make a beeline for any document that says “Investor Presentation” (usually under Events and Presentations). An investor presentation informs readers of the company’s plans regarding current/future strategy, operations, and plans to increase the shareholder value of the company. It is an immensely useful document to get yourself up to speed with the company.

Adobe’s latest investor presentation (Adobe 2021 Financial Analyst meeting slides) begins by listing its 2021 achievements and financial results (compared against its projections). I do enjoy it when companies present their financial results in this manner as the side-by-side comparison allows you to ascertain if Adobe has managed to meet its expectations.

As you can see, Adobe easily smashed its projections. Companies that consistently under promise and over deliver are poised to compound good returns for shareholders. This is also a barometer of competent management.

Step 4: Find company’s strategy to further growth in the future

Adobe then goes into its current strategy and vision to make Adobe products more accessible and productive to both consumers and businesses.

Simultaneously, they are laying out their strategy to capture more of their purported massive total addressable market ($205 Billion).

Going through the document, I am extremely impressed by Adobe’s suite of mission-critical products (Photoshop, PDF, Illustrator, etc.), its reach across multiple industries, and the number of premier companies using its products. This highlights the stickiness of Adobe products across both retail consumers as well as businesses.

Step 5: Check out company’s Past Performance

Finally, Adobe wraps things up by going through its financial and operational performances over the last 4 years. I am floored by Adobe’s financials: it has terrific growth in revenues, earnings, and cash flows over time. I must confess I was unaware of Adobe’s switch to a SaaS business model (Software-as-a-service) which has led to a sharp increase in gross profits and cash flows which consequently resulted in an upwards rerating of the stock price.

The company is also in excellent financial shape with its debt covered by cash on the balance sheet as well as its robust cash flows. The cherry on top is that management is friendly to shareholders; they have allocated surplus cash over the years to conduct share buybacks to enhance shareholder value.

Adobe’s investor presentation is seriously impressive: simple to comprehend, detailed, contains both past and projected performance, management’s strategy, and vision, as well as company-specific metrics to monitor for investors. Unfortunately, this does not extend to every single company – Apple does not even have an investor presentation!

Before leaving the IR page, you can subscribe to their mailing list to ensure that anytime the company releases a piece of information (including SEC documents), you will be notified via email.

Step 6: Review company’s SEC Documents 

10K:

Does this mean I am ready to be done with my research? Absolutely not! Investor presentations are produced by companies to entice investment from retail and institutions. If you are a company trying to do that, wouldn’t you leave some less-than-ideal facts and unpleasant conditions out of the presentation?

As such, to verify that the company is not hiding any unpleasantness, I will take a look at the company’s 10k document which is filed with the SEC. Every company listed on the stock exchanges has to produce a 10k document in which they detail the company’s performance over the entire fiscal year. Think of it as an end-of-year report card that a child (company) has to submit to their parent (SEC).

A 10k has to contain every single pertinent (accurate) information about the company. The company is not able to just omit/bury any undesirable or unflattering information lest it runs into severe punishments by the SEC. A company 10k is lengthy and filled with different legal and business jargon that make it intimidating to beginners. However, I will reveal the steps I follow to scan through the 10k efficiently and effectively.

Step 1:

Finding the 10k

• There are 2 ways to go about it
  • Use EDGAR (platform to obtain companies’ submitted SEC documents: completely free!) 
    • Type in the company name (Adobe) and click on it
    • You will come to a page that looks like this, click more fillings, then scroll until you find the link that says Form Type: 10K – “Annual Report”  
  • 10K and other SEC documents can typically be found on the company’s IR page

Step 2:

Reading the 10K

• The 10K has a table of contents that looks like this
• Each section is hyperlinked which facilitates navigation

If you have the time, I would advise reading every word. However, there are only a couple of sectors that carry the meat of the document: Business, Risk Factors, Unresolved staff comments, Legal Proceedings, Management’s Discussion and Analysis of Financial Results, Financial Statements, and Executive Comp and Ownership.

Step 3:

Business Section

• The main chunk is from pages 3 – 8. Pages 9 – 17 go further into details regarding Adobe’s product offerings as well as how it conducts its operations.
• Easy! As a rule of thumb, if you do not understand how the business functions after reading and re-reading this section, do not invest in the company.

Step 4:

Risk Factors

• Broken into these sections:
  • Company-Specific
  • Industry-Specific
  • Regulatory
  • Stock specific
  • General
• In my opinion, the more important sections are “Company and industry-specific” risks. The rest are just standard legal filler.

“Risks Related to operations of the business”:

Step 5:

Unresolved staff comments

• I like to see a “None” in this section. A workforce without outrage/dissent bodes well for the company – happy workers result in happy customers.

Step 6:

Legal Proceedings

• An empty section is ideal – no risk of a significant fine/regulatory action that disrupts the company’s operations.   

Step 7:

Management’s Discussion and Analysis of Financial Results

• I strongly recommend reading through this section as management is telling you what to pay attention to as an owner of Adobe.

Step 8:

Financial Statements and Supplementary Data

• Absolutely critical. You can check out this previously written article on how to interpret financial statements:

Step 9:

Executive Comp and Ownership (found in the 2022 proxy statement in the case of Adobe)

• You want to ensure that financial incentives are aligned with your long-term goals
  • CEO / execs not overpaying themselves while underperforming for the company
    • Important Metrics that determine executives’ pay
      • Revenue
      • EPS
      • Operating Income

I appreciate how a significant amount of compensation for Adobe’s executive team is made up of the granting of shares depending on the achievement of these objectives: total share returns over 3 years for Adobe shares and increase in net sales and earnings. 

• You want high stock ownership from insiders (Board, Executive Management)
  • Aligned with shareholder goals
    • Do their best in their jobs as they are financially incentivized
      • Insiders only hold 0.42% of shares outstanding – while the figure is small, it is not that unusual for a giant company.
  • Significant Insider buying
    • Huge plus – Insiders only buy stock significantly for one reason: they think it will go up
      • Unfortunately, there is not much insider buying from insiders recently.

Viola! Now you will have an easier time reading a 10K. Some other SEC-filed documents that I monitor include the following:

• 8K
  • Report of unscheduled material events / corporate changes at the company of importance to shareholders
• 10Q
  • Quarterly performance card of the company
• Forms 3, 4, 5
  • Detailing insider transactions and ownership of stock

Step 7: Check alternative sources of information

Last but not least, there are a couple of alternative sources of information that I rely on to further deepen my fundamental understanding of the company.

Glassdoor:

Glassdoor can be a great place to gain insight into the company’s working culture. They even have a function that rates the CEO! However, caution must be exercised if the number of ratings is low.

It appears that Adobe has an excellent work environment and their employees deeply respect their leader.

Social media forums

Sites such as Twitter, Stocktwits, and Seeking Alpha can be fertile grounds to look for other people’s thoughts on the company. Although you might take a long time to find a good piece of content, there are times when I have found genuinely great takes on companies that I have been researching.

Conclusion

And that closes my fundamental evaluation of Adobe. It is a well-managed, highly profitable, company with great growth prospects lying ahead of it. However, before electing to purchase the stock, I still would have to value the company to see if it is currently undervalued. I hope this article sheds some light on how to conduct a deeper fundamental analysis of companies and how to analyze a 10K with ease!

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Disclosure: The accuracy of the material found in this article cannot be guaranteed. Past performance is not an assurance of future results. This article is not to be construed as a recommendation to Buy or Sell any shares or derivative products and is solely for reference only