Where to Look for Ideas in This Market

by: Joe Ponzio

Everybody knows that Warren Buffett gets his investment information largely from annual reports. Today, companies call him; but, 50 years ago, Buffett was not the go-to guy if you wanted to sell your company or raise capital for your failing bank.

In an interview with Warren Buffett, Adam Smith, author of Supermoney, asked how "regular" investors can find good investment ideas.

Warren Buffett: [Investors should] do exactly what I did forty-odd years ago, which is to learn about every company in the United States that has publicly traded securities, and that bank of knowledge will do him or her terrific good over time.

Adam Smith: But there are twenty-seven thousand public companies.

Warren Buffett: Well, start with the A's.

Here's how.

Your Advantage Over Early Buffett: Technology

When the SEC stole  my idea of RSS (LOL) of  feeds for EDGAR filings, they added a great feature — RSS feeds for the latest filings. Rather than subscribing to a particular company's filings, you can be notified every time any company files an annual or quarterly report.

Among others, I have two of such SEC RSS feeds that come to my Outlook every day:
  • Latest 10-K (Annual Reports) — RSS Feed
  • Latest 10KSB (Annual Report for Small Business Issuers) — RSS Feed

Last year, more than 16,000 companies filed 10-Ks or 10KSBs with the SEC. Assuming they come in evenly (they don't, but we'll say this for simplicity's sake), that would be more than 4,000 annual reports a quarter, or roughly 44 a day, each and every day of the year. Forget holidays, vacations, or your kids' birthdays — you've got annual reports to read!

Though it sounds like an impossible task, it's not.

Most Can Be Glossed Over and Discarded

While there is much more to a company than its financials, starting with the financials will allow you to quickly dismiss thousands of these filings. Over the past two days, I've looked at more than 500 companies and only found one potential investment — a great company that is slightly overpriced. (Obviously, I'm waiting until it drops 30% or so.)

As an example of companies that can be "glossed over and discarded," look at this filing from Modena 6, Inc:
 
Modena 6 Balance SheetClick to enlarge

I know I don't need to do a thing but close the filing and move on. The worst part? I had to wait a second while the page loaded.

Another example is this filing (a small business quarterly report) from OmniReliant Holdings ((OTC:ORHI)) — the "Warning" notes are mine:

OmniReliant Balance SheetClick to enlarge
 
I'll spend more time explaining here than I spent actually reviewing the filing itself.
Warning: A Development Stage Company. I don't like "development" or "exploration" stage companies unless the numbers really jump out at me. When I see "Development" stage, I put my guard up immediately.

Warning: $17.4 million in derivative liabilities compared to total GAAP assets of $14 million (less if we had to fire-sale the businesses). I am gone.

Warning: $29 million shareholder deficit. I didn't notice this until I posted this, because I didn't spend more than five seconds on this business.

Bad Businesses? Par For The Course.

Out of 500+ businesses that I looked at, I was able to immediately discard 450 or so because of their negative balance sheets. When a company has a weak balance sheet, everything else about it is often highly unstable.

Then 98% of the remaining businesses were discarded in under a minute or two. Mediocre balance sheets, massive negative cash flows, and ungodly issuances of stock to managers were the primary reasons for passing. With such weak foundations, such poor past performance, and such disregard (or misunderstanding) of value and the use of stock options, I didn't need to spend any time figuring out where these businesses would be in the future. When they hit my radar again next year (through the RSS Feed), I'll see if anything changed.

Thus, to get through 500 or so companies took about an hour, with just three having moved to the "more research" pile. Two of those three were discarded ten minutes later; just one moved to the "yes, but wait for the price to drop" pile.

500 companies an hour / 20,000 or so companies = 40 hours a year. Add in additional time for research on the "maybes" and you could get through every filing company in about 60 or 70 hours.

If You Don't Have a Few Hours a Day

You don't have to look at every company out there. In fact, you can make very good returns by sticking with familiar brands when they are selling at a discount. But, if you want to spend the time taking your learning and investing to the next level — if you want to "start with the As" as Buffett suggests — the SEC's Latest Filing Feed is the first step.