Lesson 2 of 7
How to research a company
Fundamental analysis reads the accounts to form a view of the business. Technical analysis reads the price series instead. Here is an order of operations.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
Who writes thisEditorial processLinkedIn (opens in a new tab)X (opens in a new tab)
In one minute
- Fundamental analysis reads a company's filed accounts to judge the business, where technical analysis reads the price series instead and makes no claim about the business.
- Research runs in a fixed order, and the price is deliberately step seven of eight, never the first thing looked at.
- A thesis written before the price is known and one written after look identical on paper, and only the order, at the time, can tell them apart.
The order in which the work is done changes the conclusion. An estimate formed after the price is known is anchored on it, and there is no procedure for unanchoring an estimate afterward. Everything below follows from that one constraint.
The eight-step order, price seventh
- Read what it sells and to whom, in one sentence (Item 1 of Form 10-K).
- Set profit against cash, then run the forensic pass.
- Read the balance sheet and the debt note.
- Break down where the returns come from.
- Price the capital those returns are earned on.
- Value the business more than one way, and write the range down.
- Only now, look at the price.
- Write down what has to stay true, with a figure and a review date.
Fundamental against technical, in one line
Fundamental analysis reads filed accounts and disclosures to form a view of what a business earns, owns and owes. Technical analysis reads price and volume instead, and produces a claim about a price series, never about the business behind it. They answer different questions rather than competing on the same one, and this course is entirely about the first. Buffett's 1996 letter calls the edge of what a reader actually understands the circle of competence, and steps one and four are where that edge stops being answerable.
Why steps two and four do the most work
Step two, cash against profit and the three forensic scores together, is covered in full two lessons from here. Step four is the single most informative five minutes in the sequence: decomposing return on equity into margin, turnover and leverage, then moving to return on invested capital, says whether a high headline return is the operation or the balance sheet.
The half of the work no filing contains
Fisher's scuttlebutt answers what ten years of filed figures cannot: whether the sales force is still winning on merit, whether a competitor has quietly gotten better. It works by gathering evidence from customers, suppliers, competitors and former employees. That half of the process is not reproducible the way a filed number is, and it is covered in its own lesson, Scuttlebutt.
The calendar the sequence runs on
Under Form 10-K's General Instruction A(2), an annual report is due 60, 75 or 90 days after fiscal year end depending on filer size. Form 10-Q's General Instruction A(1) gives 40 or 45 days for a quarter. So a condition written at step eight can already be broken for most of a quarter before any document says so. Two filings invalidate the steps above them without announcing it as news: Form 8-K item 4.02, a determination that prior financial statements should no longer be relied on, and item 4.01, a change of auditor.
Where the order fails
The sequence defends against one specific failure: starting from the price and assembling reasons for it afterward. The defense only works if the reasoning is written before the price is looked at, and nobody reading the document later, including the person who wrote it, can tell a before from an after. Only the order can, and only at the time. It is also defeated by accounts that are wrong: if the figures were managed, every step operates on the managed figures, and step two detects a statistical pattern, not a fraud, on its own.
Do it on a real 10-K
- Open Item 1 for what the company sells, in one sentence.
- Open Item 8 and set net income against operating cash flow for every year shown, side by side.
- Read the debt note for the maturity schedule, then stop before opening a price chart.
Check yourself
Why does the sequence place the price at step seven rather than step one?
- Because the price is the least important figure in the process
- Because an estimate anchored on the price cannot be unanchored later
- Because prices are unreliable for the first six steps of research
Show the answer
Answer: B.
The concern is not that price is unimportant. It is that once it is seen, every earlier judgment risks being shaped by it rather than by the business.What tells a reader whether a thesis was written before or after the price was known?
- The tone of the writing, careful against confident
- The number of pages the finished document runs to
- Nothing in the document itself, only the order it was actually written in
Show the answer
Answer: C.
A thesis written either way can look identical on paper. The order is not something the finished document can prove.Under Form 8-K, which item is a company's own determination that its past financial statements should no longer be relied on?
- Item 1.01
- Item 4.02
- Item 5.02
Show the answer
Answer: B.
Item 4.02 is the non-reliance determination. Item 1.01 covers material agreements and item 5.02 covers officer departures.Sources
- Sloan, The Accounting Review, 1996: the accrual anomaly, the reason step two runs before step six rather than after it.
- Form 10-K, General Instruction A(2), and Form 10-Q, General Instruction A(1): the filing deadlines the review calendar in step eight is set against.
- Form 8-K items 4.01 and 4.02: an auditor change and a non-reliance determination, each of which can invalidate the steps above it.
- Berkshire Hathaway shareholder letter, 1996: the circle of competence, the edge that marks where step one and step four stop being answerable.
What this leaves out
- This is an order of operations, not a valuation method. Steps six and eight are each larger subjects than this lesson, and neither specifies what to write in a thesis or what to do when a condition breaks.
- The sequence assumes a single-currency US filer with a stable segment structure. Heavy segment complexity or several reporting currencies need work this order does not cover.
- Everything in steps one through six is history, not a forecast, and this lesson names no company.
- Nothing here is advice about any security.