When researching a stock you of course want to make sure that the managers aren’t doing anything ‘funny’. That’s difficult to do if you don’t have a background in accounting. But there is one simple thing you can do that will help. Find the latest 10-K for the company at the SEC website www.sec.gov. The 10-K is the document that has audited financials. Auditors don’t do a perfect job, but they do try to make sure that the company isn’t cooking the books.
Now find the auditor’s statement. It will probably go on at some length. But don’t let your eyes glaze over yet. What you are looking for is a statement that the auditors think management is on the up and up. They will talk about financial statements being presented correctly “in all material respects”. Most audit firms use that exact wording. Most 10-K’s have that. But if you see one that doesn’t, then you need to read the auditor’s statement carefully, to make sure they are not disagreeing with management about the books. If the auditors don’t agree, your course of action is really straightforward. Walk away. If auditors don’t agree with management, that’s a big warning sign of trouble to come.