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Word Searching Annual Reports for Context
Posted by: Tannor Pilatzke (IP Logged)
Date: October 21, 2013 11:12AM

You may be surprised by the fact that in 2001 about 80% of the companies in the Fortune 500 had not used the word values in their annual report. Why does this matter? The way the CEO communicates with the shareholders is of the utmost importance and an example of someone in a league of their own is Warren Buffett. He has the most elaborately and astutely written annual reports, enriching the process by telling insightful stories, jokes, and specific business details.

The annual reports are a way to give you a glimpse of the culture the organization is structured on, allowing you to discover the autonomy of the business and strengths of the foundation. Bureaucratic businesses may be more easily detected through the “tone” of the annual reports and should be avoided when possible. You may be surprised by the fact a vast amount of CEOs do not write their shareholder letters. Instead they sign off on them after an investor relation team has assembled a generic version. Warren Buffett explains that the CEO personally writing the letter is important to him because otherwise it may show that the CEO does not truly understand the business as well as some other people and therefore should probably not be in the position he or she is in.

Wells Fargo provides positive context to the annual report through a brief and insightful story.

“The stagecoach carried valuables for customers to help them pursue prosperity, achieve their dreams of financial success, connect and correspond with their friends and families. It visually represents our values—trust, security, dependability, outstanding service and convenience. It also represents one of the founding values of America: The Pursuit of Happiness.”

The type and amount of disclosure within the annual report is also another “check or X” scenario, the latter sentence meaning the disclosure within the report should be balanced with triumphs and mistakes, reflection of the past and premeditation of the future, and personalized stories providing valuable business insight. If the CEO acts honestly, with integrity, and talks frankly to the shareholders, explaining the firms culture and values through metaphors and writing, these are definitely positive traits to look for in the investment process. There are numerous studies from various Ivy institutions linking the positive correlation of the organizational culture, corporate and social sustainability, and outperformance of value creation when compared to benchmarks or peers.

Avoiding letters that involve spins, clichés, platitudes, jargon, contradictions, confusing or incomplete information or any other non-sense that you remain skeptical of, is a clear warning sign the foundation of the organizational castle is showing severe cracks. (“Fluff” could also be considered a spinning tactic.)

Buffett offers the following advice to CEOs and other stewards of capital on writing/informing partners of the past year's performance. “One unoriginal but useful tip: Write with a specific person in mind. When writing Berkshire Hathaway's annual report, I pretend that I'm talking to my sisters. I have no trouble picturing them: Though highly intelligent, they are not experts in accounting or finance. They will understand plain English, but jargon may puzzle them. My goal is simply to give them the information I would wish them to supply me if our positions were reversed. To succeed, I don't need to be Shakespeare; I must, though, have a sincere desire to inform. No siblings to write to? Borrow mine: Just begin with, Dear Doris and Bertie.”

Sounds an awful lot like the golden rule: "One should treat others as one would want others to treat oneself."

Using “Control or Command F,” word search the document for the following words (others may be added), reading the paragraphs with focus and detail surrounding the words.

· Culture

· Values

· Disclosure

· Sustain

· Steward

· Candor

· Strategy

· Sustainability

· Lead

· Vision

· Person/Personal

· Account/Accountability

· Crisis

· Authentic

The words should not be the sole focus of reading the annual report, but should simply be given more time to decompose the message, knowing it may be an important one. The company should provide detailed examples of how they are accomplishing promises they have made in the past and intend to continue to do so in the future. You can compare five to 10 years of past promises to past and present performance, ensuring management is not only talking the talk, but walking the walk. An example from AIG (AIG) (when it first began operating in Vietnam) of detail being provided but connections not being made is provided below.

“As reported last year, early in 2000 American International Assurance Company, Ltd. [AIA] received a life license from the government of Veitnam to operate a wholly owned life company in that country, the first insurance license granted by Vietnam to a U.S-based company. Our new Hanoi and Ho Chi Minh City offices opened in October. We now have an agency force of approximately 1,800 and the new company is achieving faster growth than its original business.”

The CEO at the time was Hank Greenberg, and he did score well for providing valuable, informative information. But like most CEOs he did not draw the connections and parallels of WHY? Why was AIG better off operating in Vietnam, why was it beneficial to be the first company from the industry to do so (essentially testing the waters for sharks), do the sales in Vietnam provided (in comparison to the U.S.) provide proof of faster growth? Like the majority of organizations, the lack of information provided was approximately equal to what was provided.

Next time you read an annual report, scrutinize the language and words used with skepticism, looking for a deeper connection to the firm’s culture, beliefs, attitude, vision, employees, leaders and mission. Balance your biases when approaching a company looking not for positive and negatives to weigh but looking for the real picture of what is. For examples of other excellent annual reports view General Electric under Jack Welch's tenure or Fedex under Fred Smiths leadership. For examples of corruption and a toxic culture refer to Enron or World-com annual reports in the three to five years leading up to their demise.

Further Reading:
"Corporate Culture and Performance" by John Kotter and James Heskett

Stocks Discussed: FDX, GE, WFC, BRK.A, BRK.B, ENRNQ,
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Re Word Searching Annual Reports for Context
Posted by: kfh227 (IP Logged)
Date: October 21, 2013 11:57AM

I usually find searhcing for FCF or free or "free cash" to be of value. If companies think in those terms, they are usually worth reading more about.

Stocks Discussed: FDX, GE, WFC, BRK.A, BRK.B, ENRNQ,
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Re Word Searching Annual Reports for Context
Posted by: Tannor (IP Logged)
Date: October 21, 2013 12:07PM

Thanks Kfh,

Word searching is a very valuable tool that may be utilize in many different ways when reading annual reports and SEC filings. I agree 100% that if the companies are thinking in terms of cash generation it is a check on the list of many other prerequisites.

There are plenty of words that may be used as starting points that are beneficial,

there must be some kind of linguistic screener that some quant has developed by now, no?

Stocks Discussed: FDX, GE, WFC, BRK.A, BRK.B, ENRNQ,
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Re Word Searching Annual Reports for Context
Posted by: Arjun Chan (IP Logged)
Date: October 21, 2013 10:06PM

Good one Tannor, I'll add your info to my AR reading checklist :-)

I've been reading 'Give and Take' a book recommended by Mohnish Pabrai , In the book the author talks about identifying bad CEO's or companies by just looking at the number of pages on which the CEO's photo appears. For example if we had looked at Enron's annual report before it went bankrupt the CEO's photo appeared on more than 3 Pages..and it was a Full page picture too..Also if you get a chance read the buffett recommended book 'Investing between the lines' this one has some good points to identify managements.


Stocks Discussed: FDX, GE, WFC, BRK.A, BRK.B, ENRNQ,
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Re Word Searching Annual Reports for Context
Posted by: Tannor (IP Logged)
Date: October 21, 2013 10:25PM

Thanks for the kind words Itzarjuna,

I will check out the book "Give and Take", thanks for the recommendation it sounds very interesting. I would completely agree with that basic heuristic (more personal pictures the more red flags), although I have little evidence for the theory. I am not sure where I heard it but they say never trust a tanned man in a suit, haha.

Coincidentally, "Investing between the lines" is the book that had inspired this post as I saw it lying in a pile of books earlier this morning.

Stocks Discussed: FDX, GE, WFC, BRK.A, BRK.B, ENRNQ,
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Re Word Searching Annual Reports for Context
Posted by: graemew (IP Logged)
Date: October 22, 2013 10:07AM

Some good points Tannor....however on the other hand you have to be careful not to be overly impressed by what seems to be very shareholder friendly and astute letters. I was caught once like this...the CEO wrote very impressively, but too late (after the shares plunged) I finally did more research on him and found that he was a shooting star that had only started out from nothing just 5 years before and somehow through his connections managed to become CEO of a billion dollar construction company. Another time I was impressed by a company and considering investing....but when checking the profiles of managers, found that the founder/CEO had a doctorate from an odd sounding US university. When I checked out the university I found that it was one of those degree mill companies...which only had a small office and no buildings to mention. I stopped my analysis at that point. ie you need also to check out the background of the CEO, not just base your views on what he/she writes.

Stocks Discussed: FDX, GE, WFC, BRK.A, BRK.B, ENRNQ,
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Re Word Searching Annual Reports for Context
Posted by: Tannor (IP Logged)
Date: October 22, 2013 10:21AM

Thanks for the comments Graemew,

Very great points and personal examples.

I completely agree, although sometimes the more hidden information may be harder to find, but not impossible. Did you simply use Google searches to find the information? LinkedIn can also prove to be useful when research the backgrounds of people.

I did not intend to mean that "word searching for context" is the sole function of reading annual reports or the investment process, it is just one of the tools I personally utilize under the fourth and fifth steps of my investment process. 4) Read Annual Reports and Other Regulatory Filings 5) Qualitative Analysis of Management and the Organizational Culture Including Compensation Analysis.

Stocks Discussed: FDX, GE, WFC, BRK.A, BRK.B, ENRNQ,
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