You Can Get Rich by Paying Attention
A recent article in the Wall Street Journal entitled “Tips Hide in Plain Sight” by Justin Lahart on June 14, 2017 demonstrated two qualities that I admire and respect in good research and journalism—insight and agency. The author not only shares interesting information about using discoveries provided by researchers to make better investment decisions, but he provides a great way to evaluate companies for investment. Anyone with a computer, access to the internet, and Microsoft Word can make smarter business investments with a simple trick to looking at corporate documents.
Mr. Lahart describes in his article research conducted by economists Lauren Cohen, Christopher Malloy and Quoc Nguyen on the content and length of corporate quarterly and annual regulatory filings (also known as 10-Qs and 10-Ks respectively.) By law in the United States, publicly traded companies must file reports every quarter and an annual report with the Securities and Exchange Commission (SEC). These reports contain financial statements and management changes as well as a section detailing risk factors facing the company (such as company corruption investigations). The economists decided to investigate if the information in the 10-Ks and 10-Qs related to future stock performance. To do the comparison, the researchers used computers to examine the year on year stock performance of companies compared to changes in their SEC filings. The researchers employed text mining software (software that finds information by analyzing text) to highlight changes in SEC filings from many companies in a quarter by quarter basis from 1994-2014. Interestingly, first the economists found that on the whole, SEC filings change very little from quarter to quarter, and they often contain the exact same language over and over again. Apparently, company legal counsel does not like to change the language for fear of exposing the company to risk. However, the economists found that changes to the language, especially in the section outlining risks to the company, related very strongly to stock performance. Consequently, companies that mentioned potential negative risks in their SEC filings then later experienced a drop in performance and stock value. However, stock in companies that did not change in their SEC filings outperformed the market by 22%!
Now, economists doing research on massive collections of SEC filings may sound interesting, but the individual investor may ask how does this help me? After all, I do not have access to text analytics software, but Mr. Lahart points out that anyone with a computer, access to the internet, and a copy of Microsoft Word can do their own text analysis of two SEC filings. Most SEC filings are available online from the Securities and Exchange Commission database called EDGAR. You can download some SEC filings from a company you are interested in. All you have to do then is open two of the documents in Word and under the Review tab, click Legal Blackline Compare, and Word will show you only the text that is different between the two documents. Word puts text analytics in your hands. Since the language changes little from quarter to quarter, you can easily keep track of a few companies from the comfort of your own laptop. A good place to start would be section two in the filing to find the changes in risk factors.
A recent Wall Street Journal Article revealed that investors by and large do not pay attention to information revealed in SEC filings about impending risks to the company. Research by economists using text analytics found that in general most of the text in SEC filings does not change from quarter to quarter, and that changes, especially in the risk section, forecast very effectively whether a company’s stock will be impacted. Moreover, the author points out that text analytics can also be done at home if you have a computer, access to the internet and a word processing program like Microsoft word. With Word, individual investors can easily compare the SEC filings of companies they are interested in. Empowering individual investors with easy to access tools and information makes me happy to live in the Information Age.
You can access the EDGAR database here.
You can read the Justin Lahart article here (Only available to Wall Street Journal Subscribers.)