For work, I've been reading through SEC filings, trying to be like Michelle Leder by finding salacious items buried in 10-Q/Ks. The "Risk Factors" section is always a fun one... but, the Talebian in me knows that this section will never be anything more than a psychological profile of a company's management. After all, a company's real risks will inevitably be the black swans that won't be found in this section.
So as an experiment, I thought it would be fun to look at various companies' 10-Ks from the year their stock peaked, to see how accurately their stated risk factors actually reflected the coming reality.
I thought I'd start with an easy one, a newspaper company, since the changes in that industry have (in the rear view mirror) been so pronounced and easy to understand. McClatchy (NYSE:MNI) peaked at the end of 2004 and since then it's fallen sharply, as the internet has decimated much of its business. So what do you think was identified as the top risk factor in the 10-k for 2004? Duh, newsprint costs (what were you thinking it would be?):
Newsprint is the major component of our cost of raw materials. Newsprint accounted for 14.5% of McClatchy’s operating expenses for fiscal 2004. Accordingly, our earnings are sensitive to changes in newsprint prices. We have not attempted to hedge fluctuations in the normal purchases of newsprint or enter into contracts with embedded derivatives for the purchase of newsprint. If the price of newsprint increases materially, our operating results could be adversely affected.
Oh, did you think it'd be the internet? Actually, here's the closest the whole report gets to warning about the 'net (from the section on competition):
The Company’s newspapers, direct marketing programs and internet sites compete for advertising revenues and readers’ time with television, radio, the internet, direct mail companies, free shoppers, suburban neighborhood and national newspapers and other publications, and billboard companies, among others.
Seriously, that's it. Remember, this is in 2005, not exactly the stone age in internet time. Now just by way of comparison, here's the first risk factor in this year's 10-k:
The Company’s primary source of revenue is advertising, followed by circulation revenues. In recent years, the advertising industry generally has experienced a secular shift toward internet advertising and away from other traditional media.
Newsprint is #2.
A number of Microsoft's most significant competitors, including IBM (NYSE:IBM), Sun Microsystems (JAVA),Oracle (NYSE:ORCL), and AOL (Netscape) (Time Warner (NYSE:TWX)), are collaborating with one another on various initiatives directed at competing with Microsoft. These initiatives relate in part to efforts to move software from individual PCs to centrally managed servers, which would present significant challenges to the Company's historical business model. Collaborative efforts also include the development of new platform technologies that are intended to replicate much of the value of Microsoft Windows operating systems.
This is perhaps more interesting. In 2003, the company mentioned Google (NASDAQ:GOOG) as a competitor for the first time. But, it was only identified as a competitor to Microsoft's MSN unit. The same goes for 2005. It wasn't until 2006 (!) that Google graduated to being a major competitor, rather than just a competitor at a small unit.
From time to time, you may find some glints of foresight in the 'Risk Factors' section, but for the most part the real risks aren't coming head on. The real risks are those that come at you from your blindside. That's why football teams spend so much money on a good left tackle. So while this section is worth reading, it's mainly a lagging indicator that says more about what's on the mind of management than the pitfalls that lie ahead.
Oh, here's one more interesting one. Count the number of times the word 'terror' is used in Chubb's (NYSE:CB) (insurance carrier) 10-k that came out in March 2002 (21) compared to the one that came out in March 2001 (0).