Most investors skim the press release, check the EPS beat, and move on. This is a mistake. The press release is what management wants you to see. The 10-K is what they are legally required to tell you.
There is a reason short sellers live in SEC filings. There is a reason activist investors quote footnote disclosures in their presentation decks. The 10-K is the closest thing public markets have to a confession booth—and most people walk right past it.
At Blank Capital Research, we believe the alpha is buried in the footnotes. Today, we are going back to basics with a forensic guide to reading the Annual Report, where to look, what to ignore, and where companies hide the bodies.
Here is the guide.
1. The Lead (Item 1: Business)
Start with the "boring" stuff.
You open the PDF. It is 150 pages. Do not panic. You are not reading it cover-to-cover; you are hunting for discrepancies. Think of yourself as an auditor with a short position's mentality, even if you are long. The goal is to find the places where the narrative and the numbers diverge.
Most people skip Item 1: Business, thinking they already know what the company does. They sell software. They make car parts. They run restaurants. Got it. Move on.
This is wrong.
Item 1 is the baseline for truth. It is the company's own description of itself, written under penalty of securities law. And what we look for is strategy drift—the subtle shifts in language that signal a company is either evolving or lost.
The Coverage Example: Strattec Security (STRT) For decades, their Item 1 described a mechanical key manufacturer. Locks and keys. The unglamorous business of getting into your car. But recently, the language has shifted aggressively toward "Smart Access" and "hardware-software solutions." The word "digital" appears more frequently. The competitive landscape section now references technology companies, not just other Tier 1 automotive suppliers.
If the business description changes significantly from year to year, the company is either successfully pivoting—our thesis on STRT—or flailing to find a new narrative because the old one stopped working. You have to spot the drift before the revenue line moves. By the time the transformation shows up in the financials, the stock has already re-rated.
Action: Read Item 1 every year. Compare it to last year. The changes tell you where management's head is.
2. The Risks (Item 1A: Risk Factors)
Read the redlines.
Item 1A: Risk Factors is usually a wall of lawyer-approved boilerplate. "The economy might crash." "We face competition." "Our stock price may be volatile." Thanks, counsel. Very helpful.
Ignore the standard text. It is there to protect the company from lawsuits, not to inform you. You are looking for new insertions.
When a company adds a specific new paragraph to Item 1A—one that was not there last year—their lawyers are terrified of a specific operational failure. Legal departments do not add risk factors for fun. They add them because something is happening internally that requires disclosure, and they want it on the record before it blows up.
The Coverage Example: Aehr Test Systems (AEHR) We love the technology. Their burn-in and test systems are genuinely important to the silicon carbide supply chain. But the "Zero Visibility" risk is real. You are not looking for generic supply chain warnings. You are looking for specific language about customer concentration and order timing.
When a company relies on one or two massive customers, the addition of a sentence about "delays in customer acceptance" is often the only warning you get before a guidance cut. Management will not tell you on the earnings call that their biggest customer is slow-walking an order. But the lawyers will make sure it is buried in Item 1A.
The Pro Tip: Use a diff tool (or side-by-side comparison) to compare Item 1A paragraph by paragraph. The changes are the only thing that matters. This takes fifteen minutes. It is the highest-ROI quarter hour in equity research.
3. The Spin (Item 7: MD&A)
Management's Discussion & Analysis.
Item 7 is where management explains the numbers in their own words. Revenue was up 12%. Great. But why? That is what the MD&A is supposed to tell you.
The problem is that this is also the creative writing section. A good quarter gets attributed to brilliant strategy; a bad quarter gets blamed on "macroeconomic headwinds." Your job is to test their narrative against the math.
We look for the quality of growth:
- Is revenue up because of volume (selling more units) or price hikes?
- Is operating income improving because of leverage, or because they cut R&D and are eating the seed corn?
- Did margins expand because of mix shift, or a temporary tailwind from lower input costs?
The Coverage Example: M-tron Industries (MPTI) The headline number is the record backlog—$58.8 million. But in the MD&A, we dig into the composition of that backlog. Is it short-cycle commercial orders, or long-cycle defense contracts?
Management attributes growth to "geopolitical tailwinds." Fine. But we verify if the margins on those defense contracts are holding up against tariff headwinds. If revenue is up but gross margin is down, the "tailwind" is costing them more than it is worth.
The MD&A gives you management's story. The financial statements give you the math. When the two diverge, trust the math.
4. The Truth (Item 8: Financial Statements)
Where the rubber meets the road.
Here is the first rule: The Income Statement is opinion; the Cash Flow Statement is fact.
Net income is an accounting construct, shaped by revenue recognition choices and depreciation schedules. Cash flow is cash flow. It either came in or it did not.
When we analyze a company, we work backwards. Did the business generate cash? Is cash flow from operations tracking net income, or are they diverging? A company that reports growing profits but shrinking operating cash flow is a ticking time bomb.
The Footnotes: Where the Real Work Happens
Revenue Recognition (The "When"): Check the revenue recognition policy note. Did it change? Are they booking revenue when they ship, or when the customer accepts?
- The Coverage Example: Innodata (INOD). For a company riding the AI wave, we watch Accounts Receivable like a hawk. If Receivables are growing faster than Revenue, they are shipping invoices, not deposits. So far, INOD checks out—collections are healthy—but we check this every single quarter.
The Acquisition Haze: Acquisitions are where accounting gets truly creative. The "Purchase Price Allocation" note tells you how much of the deal was real assets versus Goodwill (the accounting plug for "we overpaid and hope synergies save us").
- The Coverage Example: FitLife Brands (FTLF). When FTLF acquired Irwin Naturals, the financials got messy. We headed straight to the Purchase Price Allocation note to confirm that margin expansion was structural (better unit economics), not just accounting noise from the merger.
5. The Clock
A quick note on timing.
The 10-K is filed within 60 to 90 days of fiscal year-end depending on company size. This is not earnings season. CNBC is not running countdown clocks.
That is the point.
The 10-K contains information that was not in the earnings release. Updated risk factors. New related-party transactions. Changes to accounting policies. All of it filed quietly, weeks after the hype has faded.
We read every 10-K for every company we cover. Not because we enjoy it, but because the market often does not. And that is where the edge lives.
The Bottom Line
Reading a 10-K is an exercise in skepticism.
Management is incentivized to show you the best version of the truth. They want the stock price to go up. They want their options to vest. This is not cynicism; it is just how incentives work.
Your job is to find the version that pays the bills. The version where revenue is actually collected, where margins are sustainable, and where risks are manageable. That version lives in the footnotes, in the risk factor changes, and in the gap between what the MD&A claims and what the Cash Flow statement proves.
The 10-K is 150 pages. You do not need to read all of it. But you need to read the right parts.
The alpha is in the footnotes. It always has been.
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From the Desk of Marques Blank I write this newsletter from my desk in Chanhassen, MN, usually with a strong coffee in hand. My goal is simple: To provide you the news you need to know in the small and mid-cap world. I sort through the filings so you don't have to. |
This is how we approach every company at Blank Capital Research. If you want to see this methodology applied to specific small-cap opportunities, reach out to us here: marques@blankcapitalresearch.com
