Many companies are disclosing more information in their 2001 annual reports as a result of added investor pressures following the collapse of Enron. But some professional investors and analysts seem to be shying away from this trend based on their approaches to forensic accounting and the footnote factor.
Wall Streeters see forensic accounting as a way to dig through ever more complicated and voluminous financial reports and make an assessment of the quality of a company's earnings. Simplistic as it may sound, the media report that the footnote factor is an increasingly popular way to quickly size up the quality of a company's earnings this year.
Simply stated, the footnote factor approach says a lot of the good stuff is revealed in footnotes, but if there are too many of them, watch out. "If there's 10 or 15 pages of footnotes, move on," explains John Montgomery of Montgomery Brothers, a money management firm with offices in New York and Washington. "There's too much potential for bad things in there."
Examples of troublesome footnotes include those about off-balance sheet arrangements and related party transactions and those that deal with changes in debt structure. One certified financial analyst says she scans 10Ks for the fine print on whether a company has violated the terms of its debt covenant, or has been hit with tougher credit restrictions, such as higher rates or a larger collateral requirement.
Only one other part of annual reports contains information as telling as the footnotes, say the money mangers, and that is the risk disclosure segment of a 10K. James Delisle, head of Boston research boutique Independent Perspectives says this section is usually a mind-numbing litany of vague statements about potential risks facing the company, but it can also be a treasure trove of warnings for investors who are willing to dig beyond the boilerplate language.