One weird trick to juice up your returns

The Competitive Advantage Every Investor can have

Did you know that there is one weird trick that let’s you outperform your competitors in the stock market?

It’s called Reading the Annual Report and it’s something that only a select few investors know to do!

Don’t believe me? Check this study out.

That’s right, most investors, whether it be retail investors or sophisticated investors like investment firms, simply do not read annual reports…

What’s an Annual Report?

According to investopedia:

An annual report is a document that public corporations must provide annually to shareholders that describes their operations and financial conditions.

While the exact regulations change from country to country, as a general rule all publicly traded companies produce and distribute their annual reports to their owners.

In that Annual Report investors (or prospective investors) can learn about the business, its finances (including the balance sheet, income statement and cash flow statement), its accounting policies, auditor statements and comments, etc…

In short, an Annual Report is a one-stop-shop to understand a company, and is the single most important and comprehensive document about a company.

That’s why it’s so important to read, because if you don’t (and often even if you do) you will be missing key information and context about a business, that would (and should) meaningfully impact your decision to invest in it.

So everyone does it, right?

What does the research say?

Well, it’s not looking good for the investing expertise of the investing public…

Using data from the SEC’s EDGAR server log, we examine the consumption of financial information in filings from 2003 through 2012. The EDGAR filings represent a first-source database for investors doing fundamental research on stock valuations.

The magnitude of daily EDGAR requests for 10-Ks is surprisingly low and shows only a small difference between firms with and without publicly-traded equity.

The average publicly-traded firm has their annual report requested only 28.4 total times by investors immediately after the 10-K filing.

The lack of annual report requests suggests that investors generally are not doing fundamental research on stocks.

The study goes into greater details into the methodology of the study, as well as any confounding factors, possible explanations and whether or not the study is generally applicable.

I’ve read it all, and I encourage you to do so as well! It’s fairly small, and quite interesting from a data science perspective!

From what I can tell, while the study does have some flaws (it’s reliant on data from regulators, which isn’t the only place where those Annual Reports can be found), overall the methodology seems solid to me, and the results appear to make sense given the data described.

Ultimately it doesn’t really seem like investors are really doing due diligence to any meaningful degree, and that the group of investors who are actually looking into most companies annual reports is quite small.

Indeed this paragraph pretty much outlines the competitive advantage you can get from that:

Consistent with Gabaix’s bounded rationality model, most investors do not perceive the EDGAR filings as being an important element to consider.

It does not appear that the vast majority of investors are doing fundamental research on valuing stocks as proxied by the server log activity on EDGAR.

From a behavioral standpoint, the low number of investors carefully analyzing the annual report indicates that there are potential rewards for individuals who spend time reading over the 10-Ks.

Interestingly, all-star value investor Warren Buffett has commented in several media stories that he enjoys reading annual reports.

So that’s the trick.

That’s it.

Just read the Annual Report, and if you find information there that would change your investing approach, use that information.

That alone would provide you with an advantage over the rest of the investing (or should we say speculating) public, which should allow you to outperform them.

Let me know what you think, in the comments down below!