You will be able to summarise how a company makes money and which risks it says could hurt it most.
Ask Marcus what Larkspur does and, before this module, he'd have said "makes parts for chip companies". That's a category, not a business model. It doesn't say who pays, what they pay for, why they keep paying, or what would make them stop. An analyst's first job with any annual report is to answer those four questions in two sentences, and then to find what management says could go wrong.
The operating review and the business section describe what the company does, usually at length. Your job is to compress it. Two sentences, covering who pays, for what, and why they come back.
Here is Marcus's attempt for Larkspur, from its made-up report. "Larkspur machines precision parts and assembles modules to order for a handful of global chip equipment makers, who pay per part under multi-year supply agreements. They come back because qualifying a new supplier for a part inside a chipmaking machine takes many months, so switching is slow and costly once Larkspur is approved."
That last clause is the important one. It names the reason customers stay, and it's something Marcus can test: if switching is really that slow, Larkspur should keep its customers through a downturn even when orders fall.
For his US chip designer the two sentences read differently. It designs processors and sells them to device and data centre makers, outsourcing manufacture. Customers come back because their own products are built around its chip architecture and software tools. Writing the two side by side showed Marcus that his two chip holdings earn money in completely different ways, though both rise and fall with the same industry cycle.
A 10-K's Item 1A lists the risks management considers material. SGX reports usually cover risks in the operating review, the corporate governance report's risk management section, or a separate risk section. Either way, the text is written partly by lawyers, to show that investors were warned. A 10-K can list dozens of risks over twenty pages, many of them generic: competition, cyber attacks, key staff, economic conditions.
Reading them in order from start to finish is mostly wasted effort. Two habits make them useful.
The first is to look for what's specific. "We face competition" says nothing. "Two customers accounted for 62% of revenue, and the loss of either would materially reduce our revenue" says a great deal. Specific risks name a number, a customer, a country, a product or a contract.
The second is to look at order and change. Companies tend to put the risks they worry about most near the top. When a risk moves up the list, or a new one appears, management or its lawyers have decided it matters more than it did.
The single most useful exercise with risk factors is to put this year's section beside last year's and mark the differences. New paragraphs, deleted paragraphs, risks that moved and sentences that got longer all count.
You can do this with a text comparison tool, or by copying both sections into a word processor and using its compare function. For a 10-K the item numbers make it quick. For an SGX report, find the risk section in each year's report first.
When Marcus compared the chip designer's last two 10-Ks, three things had changed. The paragraph on export controls had moved from the middle of the section to the top three and doubled in length, which matched the 18% of revenue billed to China and Hong Kong that he'd found in lesson 4.3, Semiconductor supply chains and export controls. A new paragraph described reliance on a single foundry for its most advanced chips. And a paragraph on a former competitor's lawsuit had been deleted, because the case had settled.
Larkspur's risk section, which changes less from year to year, had one new sentence: that a major customer had begun qualifying a second supplier for some parts. Marcus marked that in red.
The risk text tells you what management chose to say. The notes often tell you more, more plainly. Two disclosures matter most.
Segment information shows revenue and profit by business line and by geography. Larkspur's segment note showed two segments, semiconductor equipment parts at 85% of revenue and coatings at 15%, with the coatings segment earning a thin margin. That told Marcus where the business really was, more clearly than any paragraph.
Customer concentration is the other. Accounting standards require companies to disclose when a single customer accounts for a large share of revenue, and many go further and give the percentage for their largest customers. Larkspur's note showed its top two customers at 62% of revenue, the figure from module 4. A business with that concentration can look stable for years and then lose a third of its revenue in one announcement. The new sentence about a second supplier read very differently once Marcus had that number beside it.
Lesson 6.4, Notes to the accounts: revenue, segments, leases and debt, goes through the notes in detail.
For the activity, write a two-sentence business model for the company you chose in lesson 6.1, then put its last two risk sections side by side and pick out the three risks that changed most.
Write a two-sentence business model for your chosen company and list the three risk factors that changed since last year.
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