Forget all the “earnings season” analysis you read last month. The real earnings season—annual 10-K filing season—is happening right now.
Every year in this six-week stretch from mid-February through the end of March, we parse and analyze roughly 2,000 10-Ks to update our models for companies with a 12/31 fiscal year end. Our analysts work tirelessly to uncover red flags hidden in the footnotes and make our models the best in the business.
There’s no way we could analyze so many filings in such a short time without our engineering team’s help. Using machine learning and natural language processing, we automate much of the rote work of data gathering and modeling. Our technology frees our analysts up to spend more time on the complicated and unusual data points that other firms miss.
Investors understand that analyzing all financial statements and footnotes is an essential part of the diligence needed to fulfill the fiduciary duty of care. How else can one make the necessary adjustments to assess a company’s true earnings and return on invested capital (ROIC)? Our innovation is to scale this diligence and make it easily accessible to our subscribers.
What We Accomplished Yesterday
Figure 1 shows the work our analysts did yesterday and over the entirety of this filing season so far.
Figure 1: Filing Season Diligence
Sources: New Constructs, LLC and company filings.
Yesterday, our analysts parsed 125 filings and collected 17,650 data points. In total, they made 2,921 adjustments with a dollar value of $599 billion. That breaks down into:
- 1,256 income statement adjustments with a total value of $37 billion
- 1,172 balance sheet adjustments with a total value of $206 billion
- 493 valuation adjustments with a total value of $355 billions
In particular, analyst Allen L. Jackson found an unusual item yesterday in Allegheny Technologies (ATI) 10-K.
On page 97 of its 2016 10-K, ATI discloses that its auditor identified a material weakness in internal control of the financial reporting of its deferred income tax asset valuation allowance. This disclosure means that ATI lacked the adequate processes in place to prevent a material misstatement of its financial position.
Companies with a material weakness in internal control over financial reporting are more likely to have to restate their earnings and are at a higher risk for a stock price crash. For this reason, we give a suspended rating to any company with an adverse auditor’s opinion.
Investors should be wary of ATI due to its history of unusual accounting practices. We highlighted the company in 2015 for its unusual pension plan assumptions, and that issue persists today. On page 66, we find that ATI expects its pension plan assets to earn a long-term annual return of 8%, whereas most companies expect to earn between 6-7% annually.
ATI’s pension assets earned a return of 6% in 2014, -2% in 2015, and 4% in 2016. This disconnect between actual and expected return on assets is a significant red flag that, along with the adverse auditor’s opinion, should lead diligent investors away from ATI.
This article originally published here on February 28, 2017.
Disclosure: David Trainer, Allen L. Jackson, and Sam McBride receive no compensation to write about any specific stock, sector, style, or theme.
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