Getting the big picture

A common criticism made about new financial analysts is that they “lack judgement” or “don’t see the big picture.” Not good, come bonus time. So what is good judgement & how can you see the big picture when hammering out your first financial models?

Get Clued In Before Asking Questions

Questions are great. But stupid questions are, well, stupid. And asking too many questions is a sure-fire way to anger your boss. So, a good starting point for sound judgement is understanding a company’s business model and its numbers…before you ask a bunch of unnecessary questions. On the flip side, trying to build a model (“Due MON at 8:00 am”) without understanding what you’re modeling will undoubtedly yield a faulty or convoluted model. So how can you gain company and industry knowledge in a hurry and without annoying your boss?

If you’re dealing with a publicly listed company, get their most recent quarterly press release (not quarterly report), look through their investor presentation, listen to a replay of their most recent conference call and check if there is any sellside research available. Sellside initiation notes are often most helpful as the research analyst is making a full-fledged case for a new company he hasn’t covered before.

Using these sources is a quick and painless way to get up to speed on a company or industry. And it is a good substitute for reading the annual report cover to cover. Importantly, take notes on what you don’t understand. You’ll probably answer many of these points yourself as you go through the various reports. But the questions that are unanswered in the end will be the kind that makes you look smart, not stupid.

Company disclosure, financial reports, presentations and press releases are usually available on a company’s website (and at www.sec.gov for US companies). If you have access to a Bloomberg terminal, a wide range of sellside reports and conference call transcripts is often available. If you can’t figure out how to maneuver the Bloomberg, you’re in good company. Just hit the “Help!” button twice and a competent Bloomberg employee will rush to your rescue.

Use Financial Reports on an “As-Needed” Basis

Using the actual financial statements – i.e. the annual & quarterly reports, prospectuses and various other statutory disclosures – is  best done on an “as needed” basis. Does that mean you can just skim them? Or you don’t have to read them at all? On the contrary.

In fact, by the time you’re done with your model, you’ll probably know these reports inside-out. You’ll learn where info is repeated throughout the report, where disclosures change from one quarter to the next…and where to point your boss when he asks why you’ve adjusted a number. So how do you reach that piercing level of company insight without the usual cover-to-cover approach?

Annual & quarterly reports and especially offering prospectuses (often hundreds of pages long) are best read while inputting and adjusting financial line-items. If you’re modeling out 2013/2014, you’ll likely be using 2010/2011/2012 as your historical basis. So you’re actually forced to look at each of the numbers to set up your model.

Carefully read each financial statement note as you input the number. That way, you’ll begin to understand what drives each number (“What is the interest rate on that senior debt? Is that disclosed anywhere?”). You’ll adjust the numbers for non-cash & non-recurring items (“About 20% of the salaries paid were non-cash stock-options expense.”). And you’ll combine various reported items into simplified model line-items (“I’ll lump these three types of receivables into one line to make the model neater.”)

The point may seem trivial: who cares when you read what, right? Wrong. Only by following the logic of the financial statements, going from top-to-bottom of each statement and reading up on one specific line-item at a time, will the information stick. Again, trying to absorb these reports otherwise is counter-productive…and extremely boring.

If a note doesn’t sufficiently explain what a number means, search for the term (or the number itself) using the “CTRL & F” function. That way you’ll quickly see where the relevant citations are throughout the report. Annual reports often have greater detail than quarterlies and offering prospectuses have even greater detail than annuals. So go back and forth between all the reports until you fully understand what you’re researching…and own the numbers you’re about to model.

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