Taking a Qualitative Look at a Prospective Stock’s Figures

by Joe Lan, CFA

One of the first steps taken by investors when researching stocks is to spend time looking at a firm’s financial statements—specifically, the income statement, balance sheet and cash flow statement.

These financial statements provide investors with figures for revenues and earnings; a summary of assets, liabilities and shareholder’s equity; and the uses of cash. Quantitative analyses of these figures are a good starting point, but when it comes to investing, it is important to remember that financial statements and ratios do not always tell the full story.

While most investors take the time to understand the quantitative element of investment research, a qualitative assessment of the figures enables investors to better judge the company as a whole. It provides an understanding of the driving factors behind the numbers and allows for a clearer judgment on a firm’s prospects going forward.

In this article


About the author

Joe Lan is a former financial analyst for AAII.
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A good resource for conducting qualitative analysis is the Form 10-K. This is an annual filing required from public companies by the Securities and Exchange Commission (SEC). The 10-K provides a comprehensive overview of a company, including its business, management, financial performance, legal proceedings and debt obligations. Though lengthy and detailed, the document can reveal important information for those who know where to look. Other useful resources include the company earnings reports and conference calls with analysts. A company’s annual report and investor presentations can also elicit useful, qualitative information. Annual reports and investor presentations can usually be found on company websites. You can find company 10-Ks using the EDGAR database on the SEC website (www.sec.gov/edgar/searchedgar/companysearch.html). In the database, you are able to search any company by name or ticker (Figure 1). The company page on EDGAR shows a sample of the filings with a link to download each document (Figure 2). You can also search for a specific filing on the company page.

The following are the key qualitative factors to consider.

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Type of Business

All companies provide a description of their business operations near the beginning of their 10-K filings. This section explains what the company does to make money. For example, in Chevron Corporation’s (CVX) 10-K, the business section starts out by stating that the company “provides administrative, financial, management and technology support to U.S. and international subsidiaries that engage in fully integrated petroleum operations, chemical operations, mining activities, power generation and energy services.” Depending on the size and scope of the company and management’s openess, this section can provide a basic overview or go into detail about the company’s business model.


An important area to examine on a 10-K or annual report is the products that the company offers. Companies typically offer a range of products, but certain companies rely on a few products for the vast majority of their sales. A company that offers relatively few products is more risky than one that offers a wide range of products. However, companies with few products also can exhibit great growth. Conversely, companies offering a wide range of products, with less revenue as a percentage of sales for each product, are less risky but they tend to grow (or shrink) at a slower rate. When going through the 10-K or annual report, be sure to ascertain how much, as a percentage of sales and earnings, a certain product generates for a firm. Realize that firms can grow very quickly with relatively few products, but they are at a greater risk of a sudden slowdown in growth. All products go through life cycles, and successful product refreshes or new product launches are necessary for a firm to continue growing. Additionally, it is important to understand the potential and risks of these products, including product saturation and possible substitutes.

In addition, the type of products produced should be thoroughly examined. Commodity products lack differentiation and typically only compete on price. Companies that offer commodity products tend to have lower margins than companies that sell differentiated, “one-of-a-kind” products. Additionally, companies that sell commodity products will be greatly affected by any change in the price of inputs, whereas companies that sell differentiated products will be better able to pass these increased expenses on to consumers.

Seasonality and cyclicality also play a huge role. Retailers, for example, usually generate the most revenue during the holiday season. Cyclical firms generally sell discretionary items, and revenues are impacted by macroeconomic trends, such as economic expansions and contractions.

Key Customers

Some companies sell products to a broad range of customers, while others rely heavily on a few key customers. Before investing in a company, be sure to research whether a company generates a large percent of sales from a few key customers. Companies that rely on a small number of key customers are at a greater risk. For these companies, losing a key customer may pose a significant challenge and lead to steep drops in revenue and earnings.

Look for a discussion on key customers in the business section of the 10-K. Most companies will mention revenues generated from each key customer and provide critical contract information. Key customers may also be included in the notes that accompany the financial statements.

Order Backlog

In certain industries, order backlogs can play a significant role in determining future sales. In the aerospace industry, for example, customers may order planes years before they are delivered. The order backlog indicates the amount of sales that have been contracted but have yet to be delivered, providing a good gauge of future sales.

Information on a company’s backlog can be found on the 10-K. Companies may also discuss their backlog in earnings press releases, on earnings conference calls or during investor presentations. Look for total backlog, when these sales are expected to be completed, the amount of work needed to complete the sales and whether the company protected itself from unexpected terminations of contracts. For companies like Boeing Co. (BA), the general trend in backlog is a better indicator than the figure itself since most of the backlog will not be realized in the company’s coming fiscal year. Boeing also breaks down backlog by business segment.

Geographical Markets

Companies operate in different geographical markets. Firms selling goods and services worldwide will often, but not always, separate sales into different worldwide regions, such as Americas, Europe and Asia-Pacific. By contrast, a company such as Wal-Mart Stores Inc. (WMT) only reports figures for domestic and international sales, without specifically breaking down international sales by regions. The company does, however, provide store counts for each country and state in which it operates.

Companies that operate internationally tend to have two key advantages. First, during domestic downturns, international sales may help stabilize revenues. Second, international markets offer an additional outlet for potential growth.

There are downsides to selling internationally, however. Weakness overseas will adversely impact the sales and earnings a company reports. Fluctuating currency valuations will make reported earnings more volatile. They will also impact a company’s ability to compete overseas, since products can become cheaper or more expensive depending on the prevailing exchange rate. Similarly, the costs of products and materials sourced from other nations will fluctuate depending on currency moves, impacting profit margins.

A summary of international sales can typically be found in the business segment of the 10-K. Companies generally disclose currency translation costs in the notes to the financial statements. Companies with major operations worldwide may also break out currency translation income and loss in the statement of consolidated income.


In order to understand a company’s prospects, investors must understand its competition. Companies generally include a section in their 10-K and annual report dedicated to the competition with which it contends. Companies in highly competitive industries that produce “commodity” products, or products with a large number of similarly priced substitutes, typically offer lower margins than companies producing highly differentiated, one-of-a-kind products.

Some companies offer extensive information on competition. Many companies list their primary competitors for each market. For example, Microsoft Corporation (MSFT) provides a competition section for each of its five operating segments. Other companies are more general in their descriptions. Instead of offering analysis on competition against specific companies or product lines, these firms give insight on industry competition as a whole. Chevron, for instance, offers only the following competition information:

“Strong competition exists in all sectors of the petroleum and petrochemical industries in supplying the energy, fuel and chemical needs of industry and individual consumers. Chevron competes with fully integrated, major global petroleum companies, as well as independent and national petroleum companies, for the acquisition of crude oil and natural gas leases and other properties and for the equipment and labor required to develop and operate those properties. In its downstream business, Chevron competes with fully integrated, major petroleum companies and other independent refining, marketing, transportation and chemicals entities and national petroleum companies in the sale or acquisition of various goods or services in many national and international markets.”

Risk Factors

In addition to competition, firms have a variety of other risk factors that should be considered. Each company is different, and understanding a firm’s specific risk factors helps investors understand the firm itself. Risk factors are a very broad category and can range from a firm’s ability to protect intellectual property rights or attract and retain talent to a firm’s ability to deal with changing commodity prices. Most risk factors listed are boilerplate items that do not provide much insight. However, there is still useful information contained in this section. Instead of listing each possible risk here, they are best discussed with a few examples.

Chevron, as an integrated oil company, lists risk factors such as exposure to the effects of changing commodity prices. The company states, “Chevron is primarily in a commodities business that has a history of price volatility. The single largest variable that affects the company’s results of operations is the price of crude oil, which can be influenced by general economic conditions, industry inventory levels, production quotas imposed by the Organization of Petroleum Exporting Countries (OPEC), weather-related damage and disruptions, competing fuel prices and geopolitical risk.”

In addition, the company cites as a risk factor its ability to find more resources, stating that, “The company is in an extractive business; therefore, if Chevron is not successful in replacing the crude oil and natural gas it produces with good prospects for future production or through acquisitions, the company’s business will decline.”

Wal-Mart, being a retail company, states that, “General economic conditions, globally or in one or more of the markets we serve, may adversely affect our financial performance. In the U.S., higher interest rates, higher fuel and other energy costs, weakness in the housing market, inflation, deflation, increased costs of essential services…and a slew of other factors may lead to lower sales or lower margins.” The company also mentions that, “Risks associated with the suppliers from whom our products are sourced and the safety of those products could adversely affect our financial performance.”

These two different companies list two completely different sets of risk factors. Though often it is difficult, or almost impossible, to predict or quantify changes in these risk factors, an understanding of the factors can at least help investors react to changes.

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Companies often list macro risks that can impact their results. These include weaker demand by customers, economic trends, interest rate trends and even the impact of global warming. Though some of these are obvious, it is important to keep an eye out for anything that is not straightforward or anything that is unexpected. For example, CECO Environmental Corp. (CECE) warns that it is the “subject of a non-public formal investigation by the SEC.”

Also, be aware that a risk a company reveals may require further research to determine the extent of the problem being referenced. Yoga apparel manufacturer Lululemon Athletica Inc. (LULU) referenced a problem it had with pants that were too sheer by saying in its 10-K: “We have occasionally received, and may in the future continue to receive, shipments of products that fail to comply with our technical specifications or that fail to conform to our quality control standards.” A good rule of thumb is to investigate further any risk that seems odd or company-specific.


A firm’s executive team plays a pivotal role in shaping a company’s future. Top-level management makes strategic decisions such as new product introductions, strategic acquisitions and geographical expansions. However, unless you own a considerable portion of a company, you probably will not get a face-to-face sit-down with a company’s executives. So the question is: How do investors go about evaluating management?

There are several resources that can provide you with an idea of management style and outlook.

To begin with, it is important to note whether the company has a stable set of top executives, especially a stable chief executive officer (CEO). A company that is a revolving door for CEOs should raise a red flag. It is also beneficial to check how, and from where, a CEO was promoted. Did the CEO come internally or not? Generally, you can expect more company stability when CEOs are promoted from within. A new outside CEO, though potentially more talented, can cause disruption among other high-level executives. The 10-K will typically list the current executive team, including a brief background of their tenure and experience.

However, the best source for individual investors is the earnings conference call. Often, top executives such as the CEO and CFO (chief financial officer) are on these calls. The first part of the call consists of a review of the quarter’s earnings report. Depending on the company, a little or a lot of insight into the business and financial trends may be provided. During the second portion of the earnings conference call, the CEO and CFO take questions from analysts and much can be gleaned from their answers. Specifically, make note if management is forthright and open when confronted with tough questions or asked for more information.

Corporate Governance

Corporate governance refers to the relationship between company management, its board and its shareholders, and how the corporation is managed. A corporation should be looking out for shareholder interests first, and good corporate governance is a reflection of this purpose. Corporate governance typically includes the rights of shareholders, the role and responsibility of the board and disclosure and transparency. Details can be found in the company charter and bylaws. The 10-K and earnings reports will detail whether more than one class of shares exists and if the company engages in shareholder-friendly actions, such as paying dividends or buying back stock. Many corporations, but not all, also provide a corporate governance section on their website.

The proxy statement will list proposed amendments to the charter, candidates to fill board of director positions, employee stock option plans and, increasingly, executive compensation. The SEC filing for the proxy statement is DEFA14A.

Make sure to also check for the existence of staggered boards and poison pills. Staggered boards mean that board members serve staggered terms, making it harder for shareholders to vote to make a drastic change to board members. Poison pills are a strategy used to defend against hostile takeovers by making the target company’s stock less attractive. (A poison pill strategy typically involves issuing additional shares that can be purchased by current shareholders if an unsolicited acquisition offer is made. The issuance of shares dilutes current ownership, making it both more difficult and expensive to acquire the company.)

Research and Development

Research and development plays a pivotal role in the prospects of a firm. Research and development represents a company investing in future products or technologies. On a company’s financial statements and 10-K filings, firms usually break out the amount they spend on research and development . Needless to say, firms in different industries spend varying amounts on research and development, so be sure to look at similar companies when making a comparison. In addition, it is helpful to analyze research and development as a percentage of sales.

Research and development spending can be a double-edged sword, however. Of course, a company needs to spend an adequate amount to develop new goods and services to generate growth. A drop in research and development spending can temporarily boost margins, and thereby profitability, but it is likely that the company will suffer down the road. However, high levels of research and development spending do not always guarantee better products and higher sales. Furthermore, it is more beneficial for a firm to allocate higher research and development spending to higher-margin product lines, especially if there are limited funds.

Patents and Licenses

Being awarded a patent offers a key competitive advantage for a company over its competitors. Patents also play an important role in encouraging companies to spend on research and development, especially in research-intense industries such as technology and pharmaceuticals.

In essence, a patent provides the patent holder with a legal monopoly over a product that the company researched and developed for a period of time. This legal monopoly limits competition and can enable the patent holder to enjoy higher margins. In addition, patent holders can license their products as well.

Not all patents are valuable, however. A patent on a product that consumers do not want lacks economic value. Patents can also be circumvented by a competitor with a product that is different from a technical standpoint, but is a viable alternative in the eyes of a consumer. Technological innovations often devalue older patents. Competitive pressures and barriers to entry can prevent product innovations from gaining traction in the market even when they appear to offer advantages and are based on patented technology. Plus, it is not uncommon for a company to acquire patents for the sole purpose of preventing another company from obtaining them.

A firm’s 10-K discusses key patents and their expiration dates. It is important to note the percentage of sales that certain patent-protected products generate, especially the products that are close to losing their patent protection. For example, Pfizer Inc. (PFE) lost patent protection on the cholesterol drug Lipitor at the end of 2011. Measured by sales, Lipitor was the best-selling drug in history and accounted for a little under $10 billion a year in revenue for the firm. After the loss of patent protection on the drug, Pfizer’s revenues declined for four consecutive quarters before picking back up agai

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Government Regulation

Government regulations are constantly changing (often depending on which political party controls Congress and the White House). Certain industries are subject to a higher amount of government regulations than others. Notably, after the 2008 financial crisis, government regulation on banks increased significantly. The “systematically important” banks currently need government approval to increase dividend payouts and make share buybacks. They are also required to have enough reserves to survive “worse-case scenarios,” such as the one encountered during the financial crisis that led to Lehman Brothers’ demise.

Certain utilities operate as regulated monopolies simply because it is more economical to do so (power cannot be economically stored, which may lead to blackouts during supply and demand imbalances; duplication of facilities is inefficient; etc). In this situation, governing bodies affect profitability and usually decide on rates of return for investors and appropriate rates to charge customers. These utilities are generally safe investments with stable, but low, rates of return.

International firms also have additional sets of government regulations to be concerned about. A firm must not only adhere to the government regulation of the country of incorporation, but must also adhere to the government regulations of any country in which it does business. For example, Nu Skin Enterprises Inc. (NUS) operates a direct sales model throughout most of the world, but is not allowed to do so in China. Rather, the company employs a paid sales force and operates stores in China.

Legal Proceedings

Legal issues can impact companies in a variety of ways. A protracted lawsuit costs money and can divert executives’ attention away from potentially profitable projects. An unfavorable outcome can result in the payment of a large settlement or the payment of royalties or can even cause a change in how the company operates. It is impossible to fully predict legal outcomes, but it is nonetheless important for investors to be aware of potential issues.

The company’s 10-K and notes to the financial statements will state if the firm is involved with any lawsuits. A company will generally describe the legal proceedings and potential liabilities, as well as make a judgment regarding the validity of the claims and the probability of the outcome. It is important to keep in mind that this is written by the executives of the company and gives only one side of the story; it can be a biased opinion.


Investors usually begin their investment research with a detailed quantitative analysis of the firm.

However, there are important elements that cannot be expressed by simply looking at numbers.

A qualitative analysis of a firm can help you understand the driving forces behind the figures. Table 1 provides a summary of the key qualitative factors to consider.


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Table 1. Qualitative Analysis Factors

Factor What to Look for Potential Pitfalls Potential Benefits
Products Few products with large percentage of sales tied to several key products Company performance tied to few products, revenues may not be as stable Successful product leads to large increase in sales
Key Customers Large percentage of sales coming from a few key customers Loss of key customer presents significant challenge that may lead to decline in revenues and earnings Sales flow can be predicted and planned for in advance
Order Backlog Large order backlog No guarantees that order backlog will translate to sales Company can carefully plan utilization of resources
Geographical Markets Large percentage of sales coming from foreign countries Increased regulation internationally; currency risk and currency translation risk Provides new growth outlets; can help smooth sales during domestic recessions
Competition Large number of small companies Low barriers of entry make it easy for competitors to enter market A company finding a competitive advantage may be able to quickly expand and dominate the industry
A few large companies Large companies are less nimble than smaller companies Large companies have economies of scale and may have pricing advantages
Management Well-thought-out succession planning, consistency at the top management levels Changing top executives may lead to exodus of senior management Well-timed succession planning leads to smoother operations and consistent mission
Corporate Governance Company management should not hold too much unchecked power, decisions should be made in the interest of shareholders Management may be running company for short-term profits instead of long-term growth Well-run firm creates maximum value for shareholders
Research and Development High spending on research and development compared to industry norms High spending does not necessarily lead to successful products and new technologies New successful products and technologies will drive future growth
Patents and Licenses Patents and licenses held and expiration dates Expiring patents ends company’s legal monopoly over a product, leading to competition and downward pricing pressure Patents lead to higher margins by offering a “legal monopoly” for a product, design or technology
Government Regulation Highly regulated environment May be costly or difficult to comply with regulation; changes may be out of company control May limit competition
Legal Proceeding Legal proceedings filed against company or filed against other companies May lead to additional costs; may take away from management focus May lead to monetary rewards
Joe Lan, CFA is a former financial analyst for AAII.


Doug from NY posted over 3 years ago:

>The SEC filing for the proxy statement is DEFA14A.

I think this is a typo. The proxy statements are DEF14A. If the proxy statement gets AMENDED, then that is a DEFA14A.

(I've looked through proxies avidly, ever since I heard that Walter Schloss used them!)

Bob Houle from Florida posted over 3 years ago:

Superb article and the "Qualitative Analysis Factors" table at the end truly reflects the author taking the extra effort to make sure the reader pulls out all the "jewels of advice" in the article. Well done. Thank you.

Tom Huggler from Michigan. posted over 3 years ago:

As an investor new to the analysis of individual companies, I found this article to be exceptional. Thank you for writing it in a clear and cogent manner. It will become my blueprint and, by itself, is worth the cost of membership in AAII.

Douglas Sewall from ME posted over 3 years ago:

Excellent article, thank you!

Douglas Sewall from ME posted over 3 years ago:

Excellent article, thank you!

G Muren from CT posted over 3 years ago:

Thank you for such a clear and detailed guide and the outline table to check with.

L Toll from CT posted over 2 years ago:

Excellent article for all investors to read and use. Please tell me how to find out when conference calls will be held.
thank you

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