Pamela P. Peterson, Ph.D., CFA

Professor of Finance Florida State University

Frank J. Fabozzi, Ph.D., CFA

Adjunct Professor of Finance School of Management Yale University

There is a wealth of financial information about companies available to financial analysts and investors. The popularity of the Internet as a means of delivery has made vast amounts of information available to everyone, displacing print and fax as a means of communication. Consider the amount of information available about Microsoft Corporation. Not only can investors find annual reports, quarterly reports, press releases, and links to the company’s filings with regulators on Microsoft’s web site, anyone can download data for analysis and listen-in on Microsoft’s conversations with analysts.

A key source of information in analyzing the earnings of a company as well as its economic well-being is provided in various financial reports required to be published by the company. In this chapter we look at these reports and other sources of information.

SOURCES OF FINANCIAL INFORMATION

There are many sources of information available to analysts. One source of information is the company itself, preparing documents for regulators and distribution to shareholders. Another source is information prepared by government agencies that compile and report information about industries and the economy. Still another source is information prepared by financial service firms that compile, analyze, and report financial and other information about the company, the industry, and the economy.

The basic information about a company can be gleaned from publication (both print and Internet), annual reports, and sources such as the federal government and commercial financial information providers. The basic information about a company consists of the following:

• Type of business (e.g., manufacturer, retailer, service, utility)
• Primary products
• Strategic objectives
• Financial condition and operating performance
• Major competitors (domestic and foreign)
• Competitiveness of the industry (domestic and foreign)
• Position of the company in the industry (e.g., market share)
• Industry trends (domestic and foreign)
• Regulatory issues (if applicable)
• Economic environment

A thorough financial analysis of a company requires examining events that help explain the firm’s present condition and effect on its future prospects. For example, did the firm recently incur some extraordinary losses? Is the firm developing a new product, or acquiring another firm? Current events can provide useful information to the financial analyst. A good place to start is with the company itself and the disclosures that it makes—both financial and otherwise.

Most of the company-specific information can be picked up through company annual reports, press releases, and other information that the company provides to inform investors and customers about itself. Information about competitors and the markets for the company’s products must be determined through familiarity with the products of the company and its competitors. Information about the economic environment can be found in many available sources. We will take a brief look at the different types of information in the remainder of this chapter.

INFORMATION PREPARED BY THE COMPANY

Documents prepared by a company can be divided into two groups:

1. Disclosures required by regulatory authorities, including documents that a corporation prepares and files with the Securities and Exchange Commission (SEC), and
2. Documents that a corporation prepares and distributes to shareholders.

Though both types of documents provide financial and related information about the company, the documents prepared for regulators differ from those prepared for shareholders in terms of the depth of information and form of presentation.

Disclosures Required by Regulatory Authorities

Companies whose stock is traded in public markets are subject to a number of securities laws that require specific disclosures. Several of these securities laws are described briefly in Exhibit 5.1. Publicly traded companies are required by securities laws to disclose information through filings with the SEC. The SEC, a federal agency that administers federal securities laws, established by the Securities and Exchange Act of 1934, carries out the following activities:

• Issues rules that clarify securities laws or trading procedure issues
• Requires disclosure of specific information
• Makes public statements on current issues
• Oversees the self-regulation of the securities industry by the stock exchanges and professional groups such as the National Association of Securities Dealers

The publicly traded company must make a number of periodic and occasional filings with the SEC. In addition, major shareholders and executives must make periodic and occasional filings. A number of these filings are described in Exhibit 5.2 and in more detail in the following sections.

10-K and 10-Q Filings

The 10-K is an annual report required by Section 13 of the Securities and Exchange Act of 1934. The 10-K filing contains the information provided in the annual report plus additional requirements, such as the management discussion and analysis (MDA), and must be filed within 90 days after close of a corporation’s fiscal year.

The 10-K comprises five parts:

The MDA is required by the SEC Regulation S-K, Item 303. This regulation requires information and discussion regarding:

^a There are different types of proxy statements: preliminary, confidential, and definitive. The most common is the definitive proxy, generally indicated with the abbreviation DEF (e.g., DEF 14A).

In addition to the specific information, the MDA should include any other information that is necessary to understand a company’s operating results, financial condition, and changes in financial condition.

The MDA provides a discussion of risks, trends, and uncertainties that pertain to the company and is a useful device for management to explain the financial results in terms of the company’s strategies, recent actions (e.g., mergers), and the company’s competitors. The MDA also provides information that may help reconcile previous years’ financial results with the current year’s. Form 10-Q must be filed within 45 days after close of a corporation’s fiscal quarter. This filing is similar to the 10-K, yet there is much less detailed information.

Proxy Statements

In addition to the financial statement and management discussion information available in the periodic 10-Q and 10-K filings, useful non-financial information is available in proxy statements. The proxy statement notifies designated classes of shareholders of matters to be voted upon at a shareholders’ meeting. The proxy statement provides an array of information on issues such as:

• The reappointment of the independent auditor
• Compensation (salary, bonus, and options) of the top five executives
• Stock ownership of executives and directors

Some of this information is innocuous (e.g., reappointment of the auditor), yet some raises a “red flag” suggesting a significant financial problem or situation. Red flags include:

• Compensation committee interlocks (i.e., member of management is a member of the board of director’s compensation committee)
• Self-dealing (i.e., the company is doing business with other companies for which a member of the company’s management has a financial interest)
• A change in auditors
• Transactions with related parties (e.g., look for family members who are managers of subsidiaries or divisions)
• Anti-takeover provisions (often referred to as “shareholders’ rights plans”)
• Management compensation that continues to increase even though the company’s performance has declined
• Three or more different types of compensation plans for the same managers
• A board of directors that consists of a majority of inside and affiliated directors. Inside directors are current employees of the company. Affiliated directors are either former employees or are employees of firms that do business with the company (e.g., the company’s banker).

Also, the information can sometimes reveal rather interesting (and perhaps unusual) information about the company’s management and their decisions. Consider a few examples from proxy statements:

• The $195,000 expenditure in 1990 by Occidental Petroleum to finance a book about Armand Hammer, its chairman at the time.¹
• In 1990, an Executive Vice-President of W. R. Grace and Chief Executive Officer of the subsidiary, National Medical Care, consented to the entry of a misdemeanor finding and to the payment of a fine for his importation of skins of endangered species in violation of federal law.²
• Mr. Goldston, the president and chief executive officer and a director of the Einstein Noah Bagel Corporation was also employed by Boston Chicken “to undertake various special projects for Boston Chicken.” Following this arrangement, Mr. Goldston became Vice Chairman of the Board and a director of Boston Chicken. It is comforting that “Boston Chicken has agreed to structure Mr. Goldston’s future projects so that his employment with Boston Chicken will not interfere with his duties” with Einstein Noah Bagel.³

8-K Filing

The 8-K statement is an occasional filing that provides useful information about the company that is not generally found in the financial statements. The 8-K statement is filed by a company if there is a significant event. The specific events that require filing this statement are:

• A change in control of the company
• An acquisition or disposition of a significant amount of assets
• The bankruptcy or receivership of the company
• A change in the company’s auditing firm
• A resignation of a member of the board of directors because of a disagreement with the company’s operations, policies, or practices

For example, in Discovery Zone’s June 3, 1996 8-K filing, they reported information regarding their auditors that provides a “red flag.”

On June 3, 1996, Discovery Zone, Inc. (the “Registrant”) was informed by its independent accountants, Price Waterhouse LLP (“PW”), that PW declined to stand for re-election as the Registrant’s independent accountants for the year ending December 31, 1996. The Board of Directors of the Registrant did not recommend or approve the change in independent accountants.

In addition, any other event that the company deems important to shareholders may be reported using an 8-K filing. Because 8-K filings are triggered by major company events, it is useful for the analyst to keep abreast of any such filings for the companies that they follow.

Registration Statement and Prospectus

When a corporation offers a new security to the public, the SEC requires that the corporation prepare and file a registration statement. The registration statement presents financial statement data, along with detailed information about the new security. A condensed version of this statement, called a prospectus, is made available to potential investors.

Documents Distributed to Shareholders

The objective of financial reporting is to “provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions.”⁴ With that objective in mind, the financial reports prepared and distributed by the company should assist users in assessing “the amounts, timing and uncertainty of prospective net cash inflows of the enterprise.”⁵ Therefore, the financial reports to shareholders are not simply a presentation of the basic financial statements—the balance sheet, the income statement, and the statement of cash flows—but also communicate additional non-financial information, such as information about the relevant risks and uncertainties of the company. To that end, recent changes in accounting standards have broadened the extent and type of the information presented within the financial statements and in notes to the financial statements. For example, companies are now required to disclose risks and uncertainties related to their operations, how they use estimates in the preparation of financial statements, and the vulnerability of the company to geographic and customer concentrations.⁶

The annual report is the principal document used by corporations to communicate with shareholders. It is not an official SEC filing; consequently, companies have significant discretion in deciding on what types of information are reported and the way it is presented. The annual report presents the financial statements (the income statement, the balance sheet, and the statement of cash flows), notes to these statements, a discussion of the company by management, the report of the independent accountants, and, for fiscal years beginning after December 15, 1997, financial information on operating segments, product and services, geographical areas, and major customers.⁷ Along with this basic information, annual reports may present 5- or 10-year summaries of key financial data, quarterly data, and other descriptions of the business or its products.

Because of the wide latitude that companies have in presenting the information to shareholders, the reports range from the austere to the lavish (e.g., Walt Disney Company’s 1997 report, with its 8-page letter from CEO Michael Eisner and 44 pages describing its products). Some are straightforward (e.g., Berkshire Hathaway) and some are just silly (e.g., Gulf Canada Resources Ltd.’s depiction of its CEO as a “secret agent”).⁸ Quarterly reports to shareholders provide limited financial information on operations. These reports are simpler and more compact in presentation than their annual counterparts.

In addition to the annual and quarterly reports, companies provide information through press releases using commercial wire services such as PR Newswire (www.prnewswire.com), Business Wire (www.businesswire.com), First Call (www.firstcall.com), or Dow Jones (bis.dowjones.com). The wire services then distribute this information to print and Internet mediums. The information provided in press releases includes earnings, dividend, new product, and acquisition announcements.

Letter to Shareholders

The letter to shareholders included in the annual and quarterly reports is sometimes dismissed by analysts and investors as unimportant because the management discussion analysis in the 10-K and shareholder report provides more detailed information. Moreover, management has less flexibility in preparing the MDA. If management is found to materially mislead investors in the MDA, SEC action can be taken. In contrast, no action will be taken by the SEC if the chief executive officer’s letter to shareholders—typically prepared by the firm’s investor relations or public relations staff—is optimistic despite the financial difficulties currently facing the firm.

It is because of the flexibility that management has in preparing the letter to shareholders that there may be a material difference between the statements made in the MDA and the letter to shareholders. Thornton O’Glove, former publisher of the Quality of Earnings Report, refers to this as differential disclosure.⁹ O’Glove provides the following example of differential disclosure.¹⁰ While the example is now 15 years old, the principle still holds.

In the early 1980s one of hottest microcomputer stocks was that of Convergent Technologies (CVGT). The key to the company’s future prospects rested with a few key products it had developed. In 1983, this company reported earnings of $0.40 a share compared to $0.42 in 1982. The letter to shareholders in the 1983 annual report was quite optimistic and began by noting that “1983 was a year of progress and challenge for Convergent Technologies.” The balance of the letter to shareholders was relatively upbeat, but there were exceptions. The letter noted, for example, that shipment of one of its key product, NGEN, was below expectations and costs were above expectations. The reason given in the letter was: “Slow manufacturing start-up and disappointing performance by some suppliers.” The letter also praised another product, WorkSlate (a powerful portable microcomputer which can also function as a terminal) and stated that: “These machines were sent as ‘high tech stocking stuffers’ to initial customers ordering through the American Express Christmas catalog,” with a good reception.

The financial data showed that revenues rose from $96.4 million to $163.5 million, net income went from $11.9 million to $14.9 million, but CVGT earned only $0.40 per share compared with $0.42 in 1982 due to a substantial increase in the number of shares outstanding. In spite of these performance results, the letter ended on this note: “Upon reflection, 1983 was a year of investment and a year of rewards… We have retained our tough operating culture and entrepreneurial spirit, and will continue to set demanding goals for ourselves.”

Now let’s look at what was said in the MDA in the 1983 10-K for this company. The reader is told that there was only one supplier for one of its main products, a microprocessor, and only one supplier for the disk drives. The MDA stated that: “To date the disk drives have been manufactured in limited quantities and the microprocessor is on allocation from its manufacturer.” The MDA claimed that this had no material impact upon the business. However, later in the 10-K the following was stated: “with the increased demand for certain components in the computer system industry the Company believes that there is a greater likelihood that the Company will experience such delays.” Further, “some of these new components have yet to be manufactured in volume by their suppliers. The Company’s ability to manufacture these products may be adversely affected by the inability of the Company’s vendors to supply high quality components in adequate quantities.” For another key product of the company, a similar situation existed.

For a more recent example, consider the perspectives on operating profit used in PepsiCo. Inc.’s 1997 annual report and 10-K. Factually correct data can be presented in both the annual report and the 10-K, but interpreted with different emphasis. In PepsiCo Inc.’s annual report’s Letter from the Chairman,

“In snacks and beverages—called ‘continuing operations in the financial pages’—our operating profit grew 30% and earnings per share grew 62%. Operating profit margins improved by almost three percentage points.”

A 30% increase in operating profits is quite impressive. In the MDA of the 10-K, a slightly different—and slightly less “rosy”—reading of the data is presented, with the 30% increase in reported profit and only a 13% increase in ongoing operations’ profit:

*Ongoing excludes the effect of the unusual items (see Note 2).

In 1997, reported operating profit increased $622 million. Ongoing operating profit increased $336 million reflecting segment operating profit growth of $392 million or 14%, partially offset by a $56 million or 32% increase in unallocated expenses. The increase in segment operating profit primarily reflects the volume gains and lower raw material costs in worldwide Beverages. The increase in unallocated expenses relates to higher corporate expenses and foreign exchange losses in 1997 compared to gains in 1996.” (PepsiCo Inc. 1997 10-K, p. 13)

And although the operating profit margin improved from 10.0% to 12.7% (the “almost three percentage points”), using data that is presented in both the annual report and the 10-K, the analyst can calculate that 1997’s margin was lower than 1995’s margin of 13.7%.¹¹

The point is that the analyst may find the letter to shareholders interesting. However, the MDA may identify where potential problems may exist, while the letter to shareholders may present a more rosy picture of the future prospects of the firm.

Issues in Using Financial Statement Data

There are a number of issues that should be considered in using the financial statement data provided in company and quarterly reports. We will look at these issues in the chapters to follow. For now, here are just three such issues:

• The restatement of prior years’ data
• The different accounting standards used by non U.S. companies
• Possible “off-balance sheet” activity

Source: Harnischfeger Industries, Inc., 1991 Annual Report, pp. 34-35, and Harnischfeger Industries, Inc., 1995 Annual Report, pp. 46-47.

The Restatement of Prior Years’ Data

When a company reports financial data for more than one year, which is often the case, previous years’ financial data are restated to reflect any changes in accounting methods or acquisitions that have taken place since the previous data had been reported. Consider the case of Harnischfeger Industries, Inc. shown in Exhibit 5.3. The originally reported data for 1991 are shown alongside the restated 1991 data reported in the 1995 financial statements. So which data are correct? Both. The 1991 data has simply been restated in 1995 to reflect accounting changes and acquisitions since 1991 to make the data comparable to the current 1995 data. Therefore, the analyst must consider which data are most appropriate to use in the analysis.¹² If, for example, the analyst is looking at Harnischfeger and its competitive position in 1991, the analyst would want to use the as-reported 1991 data. If, on the other hand, the analyst is looking at trends in some of the data in an effort to forecast future operating performance or financial condition, the restated 1991 data are more appropriate.

There Are Different Accounting Standards Used by Non-U.S. Companies

Another concern is dealing with financial statements of non-U.S. reporting entities. There are several reasons for this concern. First, as of this writing, there are no internationally acceptable standards of financial reporting. This includes not only the accounting methods that are acceptable for handling certain economic transactions and the degree of disclosure, but other issues. Specifically, there is no uniform treatment of the frequency of disclosure. Some countries require only annual or semiannual reporting rather than quarterly as in the United States. Moreover, there is a major concern with non-U.S. auditors. The enhancement role played by auditors in some countries is far from ideal, with little emphasis on the independence of the auditor and the reporting entity. In fact, in some countries, the nation’s securities laws may require that the auditor be a member of the governing board of the reporting entity. Even where there is an independent auditor, the education and training of auditors may be inadequate. And some blame lax accounting standards for the problems in the Asian, Russian, and Latin American markets, where the poor quality of financial information make it difficult for investors to assess companies—operating performance and risk.¹³ The International Accounting Standards Committee (IASC) has attempted to resolve many of these concerns. However, at this time, an analyst should look extremely closely at non-U.S. financial reports, particularly for issuers in emerging markets.

There May Be “Off-Balance Sheet” Activity

There have always been some corporate investing or financing activities that simply do not show up in financial statements. Though there have been improvements in accounting standards that have moved much of this activity to the financial statements (e.g., leases, pension benefits, post-retirement benefits), opportunities remain to conduct business that is not represented adequately in the financial statements. An example is the case of joint ventures. As long as the investing corporation does not have a controlling interest in the joint venture, the assets and financing of the venture can remain off the balance sheet. Limited information is provided in footnotes to the statements, but this information is insufficient to judge the performance and risks of the joint venture. The opportunity to keep some information from the financial statements places a greater burden on the financial analyst to dig deep into the company’s notes to the financial statements, filings with the SEC, and the financial press.

INTERVIEWING COMPANY REPRESENTATIVES

Interviewing representatives of a company may produce additional information and insight into the company’s business. The starting place for the interview is the company’s investors’ relations (IR) office, which is generally well-prepared to address the analyst’s questions.

The key is for the analyst to prepare before meeting with the IR officer so that the interview questions can be well focused. This preparation includes understanding the company’s business, its products, the industry in which it operates, and its recent financial disclosures. The analyst must understand the industry-specific terminology and any industry-specific accounting methods. In the telecommunications industry, for example, the analyst must understand measures such as gigahertz and minutes-in-use, and such terms as bandwidth, point-of-presence, and spectrum.¹⁴ As another example, an analyst for the oil and gas industry should understand that a degree day is a measure of temperature variation from a reference temperature.

The analyst must keep in mind that the IR officer has an obligation to treat all investors in a fair manner, which means that the IR officer cannot give a financial analyst material information that is not also available to others. There is also information that the IR officer cannot give the analyst. For example, in a very competitive industry it may not be appropriate to give monthly sales figures for specific products. The analyst must understand the competitive nature of the industry and understand what information is typically not revealed in the industry.

Because the analyst comes armed with knowledge of the company’s financial statements, the questions should focus on taking a closer look at the information provided by these disclosures:

• Extraordinary or unusual revenues and expenses
• Large differences between earnings from cash flows
• Changes in how data is reported
• Explanations for deviations from consensus earnings expectations
• How the company values itself versus the market’s valuation
• Sales to major customers

An analyst that uses a statistical model to develop forecasts for the company or its industry may, of course, require very specific data that may not be readily available in the financial statements.

It is sometimes useful to determine what the company expects to earn in the future. Though companies may be reluctant to provide a specific earnings forecast, they will sometimes respond to a query regarding analysts’ consensus earnings forecasts. In their response about analysts’ forecasts, the company may reveal its own forecast. If a company provides a forecast of its earnings, the analyst must consider the forecast in light of the company’s previous forecasting; for example, some companies may consistently underestimate future earnings in order to avoid a negative earnings surprise. Further, the company’s forecast or response to a consensus forecast may be accompanied by significant defensive disclosures that concern the risks that the company may not meet projected earnings.

INFORMATION PREPARED BY GOVERNMENT AGENCIES

Federal and state governmental agencies provide a wealth of information that may be useful in analyzing a company, its industry, or the economic environment.

Company-Specific Information

One of the most prominent innovations in the delivery of company information is the Securities and Exchange Commission’s Electronic Data Gathering and Retrieval (EDGAR) system that is available on the Internet (www.sec.gov). The EDGAR system provides on-line access to most SEC filings for all public domestic companies from 1994 forward. The primary financial statement filings, such as the 10-K and 10-Q, are required EDGAR filings, though some filings (e.g., insider security ownership and 10-K filings of foreign corporations) are optional. The EDGAR system provides access within 24 hours of filing, providing up-to-date information that is accessible to everyone.

In addition to the EDGAR system at the SEC site, several financial service companies provide free or fee access to the information in the EDGAR system in different database forms that assist in searching or database creation tasks.¹⁵

Industry Data

The analysis of a company requires that the analyst look at the other firms that operate in the same line of business. The purpose of examining these other companies is to get an idea of the market in which the company’s products are sold: What is the degree of competition? What are the trends? What is the financial condition of the company’s competitors?

Several government agencies provide information that is useful in an analysis of an industry. The primary governmental providers of industry data are the U.S. Bureau of the Census and the Bureau of Economic Analysis, an agency of the U.S. Department of Commerce. A recent innovation is the creation of Stat-USA, a fee-based collection of governmental data. Stat-USA is an electronic provider of industry and sector data that is produced by the U.S. Department of Commerce. The available data provided for different industries include gross domestic product, shipments of products, inventories, orders, and plant capacity utilization.¹⁶

The government classification of businesses into industries is based on the North American Industry Classification System (NAICS).¹⁷ NAICS is a recently adopted system of industry identification, replacing the Standard Industrial Classification (SIC) system in 1997.¹⁸ The NAICS is a 6-digit system that classifies businesses using 350 different classes. The broadest classification comprises the first two digits of the 6-digit code. These are listed in Exhibit 5.4. The NAICS is now the basis for the classification of industry-specific data produced by governmental agencies. Like the SIC system before it, the NAICS will, over time, become the basis for the classification of companies for industry-specific data used by non-governmental information providers as well.

Source: http://www.census.gov/epcd/www/naics.html

Economic Data

Another source of information for financial analysis is economic data, such as the gross domestic product and consumer price index, which may be useful in assessing the recent performance or future prospects of a firm or industry. For example, suppose an analyst is evaluating a firm that owns a chain of retail outlets. What information will the analyst need to judge the firm’s performance and financial condition? The analyst needs financial data, but they do not tell the whole story. The analyst also needs information on consumer spending, producer prices, and consumer prices. These economic data are readily available from government sources, a few of which are listed in Exhibit 5.5.

INFORMATION PREPARED BY FINANCIAL SERVICE COMPANIES

A whole industry exists to provide financial and related information about individual companies, industries, and the economy. The ease and low cost of providing such data on the Internet has fostered a proliferation of information providers. However, the prominent providers in today’s Internet-based world are some of the same providers that were prominent in the print medium.

Company-Specific Information

Information about an individual company is available from a vast number of sources, including the company itself through its own web pages. In addition to relaying the company’s financial information that is presented by the company through its communication with shareholders and regulators, there are many financial service firms that compile the financial data and present analyses.

Several sources of data on individual companies are listed in Exhibit 5.6. This is by no means an exhaustive listing because of the large and growing number of information providers. The providers distinguish themselves in the market for information through the breadth of coverage (in terms of the number of companies in their database), the depth of coverage (in terms of the extensive nature of their data for individual companies), or their specialty (e.g., the collection of analyst recommendations and forecasts).

Industry Data

The first step in analyzing the industry is to define the company’s industry. The NAICS and its predecessor, the SIC, are systems of classification of companies, yet they do not classify companies—they simply set up a coding system that once the company’s productive activities are identified by the analyst, a company can then be classified into a specific, coded industry. Though it may seem a simple task, the fact that most companies operate in more than one line of business complicates the definition of the industry and the analysis process. Consider RJR Nabisco which operates in both the tobacco and the food industries, contributing 49% and 51% of net sales, respectively.¹⁹ Because it operates in two different industries, it is difficult to classify RJR Nabisco into one or another NAICS code. As a result of its operating significantly in two industries, the financial analyst must analyze both of these industries.

The classification of companies into industries is based on judgment and different financial reporting services and different analysts may classify the same company into different industries. One provider may classify a company based on the line of business that generates the largest percentage of sales, whereas another provider may classify a company according to the largest percentage of assets in that industry. The analyst must be aware of how the reporting service classifies companies into industries when using industry data.

In addition to the classification problem, another problem arises in the calculation of industry statistics that may be used as inputs into the analysis. Consider an industry comprised of the following four companies:

What is this industry’s return on assets? Is it the arithmetic average of 17%? That’s one way of looking at it. But what if the companies are quite different in terms of size? If company A has $10 million in assets and companies B, C, and D each have only $1 million, the simple average of 17% does not appear to adequately represent the industry’s return. It seems reasonable that some type of weighting be applied to reflect the difference in size, though the choice of weights is left to the judgment of the analyst. If the analyst is using industry averages that are prepared by someone else, it is important for the analyst to understand how the average is derived.

Aside from the financial statement data, the analyst may need to collect additional information about a company and industry that is industry-specific. For example, in analyzing the airline industry, the load factor (the percentage of seats sold) is an indicator of activity that is related to an airline’s performance. Additional examples of industry-specific factors are described in Exhibit 5.7. It is important for the analyst to understand the type of information that is relevant for an analysis.

A number of financial information providers offer industry-specific data and compile financial data by industry. Some services, such as Standard & Poor’s Compustat and Value Line, provide industry data based on their large universe of stocks covered in their database of individual company financial data.

Economic Data

Much of the economic data that is used in financial analysis is taken from government sources, though some information is independently produced through surveys and research. There are many commercial services that collect and disseminate this and other information. These services include AP Business News (www.ap.org), Bridge (www.bridge.com), and Business Wire (www.businesswire.com). Financial publications, such as the Wall Street Journal (www.wsj.com), Investors Business Daily (www.investors.com), and the Financial Times (www.ft.com), provide economic data in both in print and electronic forms. In addition, databases, such as McGraw-Hill’s DRI U.S. Central Data Base (USCEN), collect and market historical series of U.S. economic and financial data.

SUMMARY

Companies prepare and distribute information for regulators and shareholders. This information includes annual and quarterly financial reports (e.g., 10-K, 10-Q). Additional information may be gathered through interviewing a company’s representatives. Effective use of the interview as a source of company information requires extensive preparation and knowledge of the company by the analyst. Government agencies and commercial services prepare and disseminate information about individual companies, industries, and the economy.