I'm constantly amazed at how people decide to invest in a stock.
For example, a professional money manager told me he was buying Coca-Cola Co. shares because he liked the taste of Coke Zero shortly after it was introduced in 2005. The stock is currently trading at about the same price it was at in 1997.
If you want to pick stocks like a pro, then you've got to do the nitty-gritty, and that's reading the company's filings with the Securities and Exchange Commission. Yes, some of them can be unbelievable dull. But this is where you can determine if the company is a hidden gem, or a time bomb waiting to explode. (Definitions of all SEC filings can be found here.)
So, here are some of the SEC filings that you should read on any company before you buy its stock, and what you should be looking for. All SEC filings are available at the agency's Web site.
Form 8-K: A report of unscheduled material events or corporate changes that could be of importance to the shareholders or the SEC. Examples include an acquisition, bankruptcy or a change in fiscal year. These are potential gold because they disclose possible stock-moving information, such as a company that's been taken over by regulators.
Just to show you how much of a geek I am, I have an all-time favorite Form 8-K. It was filed by Superior National Insurance, a California-based workers' compensation insurance company.
The company, according to this 8-K filed in March 2000, disclosed that it had been taken over by regulators, the top executives had been fired, NASDAQ had halted trading in the stock, that it had hired a bankruptcy attorney and the only way to reach the executive team was to leave a voice mail at a specific number.
That, my friends, is not a stock that you want to be owning. So it shows the importance of reading 8-K filings.
Form 10-K: The annual report that public companies file with the SEC. It provides a comprehensive overview of the company's business. The report must be filed within 75 days after the end of the company's fiscal year.
Form 10-Q: A report filed quarterly by public companies. It includes unaudited financial statements and provides a continuing view of the company's financial position during the year. The report must be filed for each of the first three fiscal quarters of the company's fiscal year and is due within 35 to 45 days of the close of the quarter, depending on the size of the company.
With both the 10-K and 10-Q, a midlifer should look at a couple of disclosures. One that always peeks my interest is whether the company is buying back its shares in the market. If it is, has the rate of repurchasing stock increased or decreased from the previous quarter or the previous year? That could be a sign of what the company thinks about the future prospects of its stock price.
If it's buying back more, then the company likely thinks its stock is cheap. The opposite is also true — if the company is repurchasing fewer shares than before, then maybe it thinks the stock is fully valued.
I'm also a regular reader of the "litigation" section in the 10-K and 10-Q filings because a company will often say whether it has set aside any money to pay for lawsuits it might lose. You don't want to own a stock of a company with a lot of potential litigation losses.
DEF 14A: This is also known as the proxy statement, and it tells you the compensation of the top five executives from the previous year. I like to see compensation rise or fall in tandem with the performance of the company's stock price. Sadly, that rarely happens.
Schedule 13D: A form filed by anyone acquiring a beneficial ownership of 5 percent or more of any equity security registered with the SEC.
Let's face it, if a professional investor with millions of dollars to move around in the market is making a big bet on a company, then maybe you can benefit from seeing these 13Ds filed with the SEC and make the same bet.
That's what I call smart investing. Unless, of course, that investor is picking stocks by the taste of the company's products.