Where Research Starts

Why this matters

Part 3 showed how to understand a business and read its numbers. Part 4 turns that into a process for a real company: finding information, judging how reliable it is, and working out whether the price makes sense. This lesson is the starting point. Done well, research isn't about collecting as much information as possible. It's about answering a short list of questions from sources you can trust.

Picking companies is optional

It's worth saying first: you don't have to research individual companies to invest well. In his 1996 letter to shareholders, Warren Buffett wrote that most investors would do better in a low-cost index fund than with most professional managers. He also said that investors who choose to build their own portfolios don't need to be experts on every company, only on the ones within what he called their circle of competence, and that knowing where that circle ends matters more than how big it is.¹ Index Funds covers the first path. This part covers the second.

Start with questions, not the stock price

A share price tells you what the market thinks today. It doesn't tell you what the business is. Starting from the chart, or from someone's tip, tends to send you looking for reasons to agree. Start instead with the questions from No Single Number Tells the Story, and find each answer in the most reliable place.

Question	Where to find the answer
How does it make money?	Annual report: Business section
What could go wrong?	Annual report: Risk Factors
How has it performed, and why?	Annual report: financial statements and management's discussion
What's changed since the annual report?	Quarterly reports and current reports on major events
Who runs it, and how are they paid?	Proxy statement and insider filings
What does management say about the outlook?	Earnings releases and earnings calls
Is the price reasonable?	Your own valuation, covered later in this part

Almost every answer comes from the company's own filings. The SEC describes the Business section of the annual report as a good place to start to understand how a company operates.² All of these filings are free on the SEC's EDGAR database, which you can search by company name or ticker symbol.³ The next lessons cover each source.

A first pass, then a decision

You don't need to read everything before deciding whether a company is worth more time. A first pass of an hour or two can cover the essentials: read the Business section, skim the Risk Factors, and look at several years of revenue, margins, cash flow, and debt. Then decide among three outcomes:

• Worth deeper research: you understand it, and something about it is interesting.
• Not interesting: you understand it, and nothing stands out.
• Too hard: you can't tell how it makes money, or what would change its future. That's a perfectly good answer. It means the company sits outside your circle of competence.

Key takeaways

• Research means answering a short list of questions from reliable sources, then judging the price.
• Start with the company's annual report, especially the Business section, not with a chart or a tip.
• Stay within your circle of competence. Knowing its edges matters more than its size.
• "Too hard" is a valid conclusion, and index funds are a sound alternative to picking companies.

Check your understanding

A friend tells you a company's stock doubled this year and will double again. What's the best first step if you want to look into it?

1. Study the price chart to find a good moment to buy before it doubles again.
2. Read the Business section of its annual report to understand how it makes money.
3. Search social media for other investors who own it and see what they expect.

After an hour with a biotech company's annual report, you can't tell how its experimental drugs will fare or how to value them. What's the most reasonable conclusion?

1. Buy a small amount anyway, since owning it will make you study it more carefully.
2. Keep reading until you're sure, however long it takes.
3. File it under "too hard" for now: it's outside your circle of competence.

What's next

Not all information is equally reliable. The next lesson, Primary vs. Secondary Sources, shows how to tell the original record from someone's take on it.