Chapter 5. Reading disclosures

Why disclosures are the most important information

News, online communities and broker reports are all information someone has already interpreted. A disclosure is first-hand information a company publishes itself as required by law, and the company and its executives are liable if it is wrong or incomplete. Disclosures by Korean listed companies are open to everyone on the Financial Supervisory Service’s electronic disclosure system (DART) and the exchange’s disclosure system (KIND).

Important information must not spread through the market before it is disclosed. Trading on material non-public information learned before disclosure is illegal (insider trading), and companies are also banned from giving information early to selected people (the fair disclosure rule).

Types of disclosure and deadlines

Reading preliminary earnings disclosures

After a quarter ends, a company publishes its preliminary operating results as a fair disclosure, before the formal quarterly report. What matters is less the size of the numbers than what they are compared with.

• Versus the same quarter last year (YoY): a comparison free of seasonality. The most important for most industries.
• Versus the previous quarter (QoQ): used to see whether a trend is turning. Interpret with care in highly seasonal industries.
• Versus market expectations (consensus): share prices react to the gap from expectations more than to the results themselves. That is why a stock can fall even on record results.
• The direction of sales and profit: if sales rose but the operating margin fell, cost of goods or selling expenses weighed more heavily.

Major event reports: share issues, convertible bonds, mergers

What to check in a rights offering disclosure

1. Allocation method: to shareholders, public offering, or third-party allotment. With a third-party allotment, who is buying is the key.
2. Issue price and discount: how much below the market price the shares are issued. The bigger the discount, the bigger the loss for existing shareholders.
3. Use of proceeds: capital spending, working capital, debt repayment or acquiring another company. If “debt repayment” keeps repeating, it may signal financial strain.
4. The share of new shares: work out what percentage of existing shares they are.

What to check in convertible bond (CB) and bond-with-warrant (BW) disclosures

• The conversion price and conversion price reset (refixing) terms — how far the conversion price can fall if the share price drops
• The date conversion requests can begin — shares can reach the market after this date
• Put options and call options — whether the call option belongs to the largest shareholder
• The unconverted balance of CBs and BWs already issued — the accumulated potential supply

What to check in merger and split disclosures

Check how the merger ratio was set (for listed companies, on the market-price basis set by law), the price and period of appraisal rights that let opposing shareholders ask the company to buy their shares, and, for a split, whether it is a spin-off or a split-off into a subsidiary (chapter 1).

Ownership disclosures: the 5% report and insider trades

• Large holding report (the 5% rule): anyone who comes to own 5% or more of a company must report it, and report again each time the holding changes by 1% or more. The report also states whether the purpose is “participating in management” or “simple investment”. You can spot activist funds arriving and changes in the largest shareholder’s stake here.
• Reports of holdings by executives and major shareholders: executives and major shareholders with 10% or more must report when they buy or sell. Several insiders buying together means something different from selling, but many sales are for personal reasons such as taxes or loan repayment, so don’t jump to conclusions.
• Stock-backed loans by the largest shareholder: if a disclosure shows the largest shareholder borrowed against their shares, there is a risk that a big price drop forces the collateral to be sold, putting the stake on the market.

Audit opinions and going-concern uncertainty

The external auditor gives one of four opinions on the financial statements in the annual report.

The order for reading disclosures

1. Skim the list of disclosures over the last one or two years to see whether rights offerings, CB issues, changes of largest shareholder or lawsuits keep repeating. The list alone reveals a lot about a company’s character.
2. In the “business overview” of the annual report, read what the company makes money from, its main customers and raw materials, and the competitive situation.
3. In the financial statements and notes, look at sales, profit, cash flow, debt maturities and related-party transactions (chapter 6).
4. Check the ownership structure (largest shareholder, 5% holders, treasury shares) and the dividend policy.
5. If there are amended disclosures, compare what changed. A company whose numbers are amended often may have weak internal controls.

Reading broker reports and consensus

Analyst reports from brokers are secondary material interpreting disclosures. They contain industry structure, peer comparisons and earnings models and help a lot with study, but there are a few things to know when reading them.

• The spread of ratings: Korean reports very rarely say “sell”. Whether the target price was cut or earnings estimates changed tells you more than the rating.
• Estimate revisions: when several brokers raise or cut earnings estimates together, the share price often moves with them. Look at the direction of change over recent weeks rather than one consensus number.
• Check the assumptions: target prices are often set as “estimated earnings × target multiple”. Seeing which earnings (this year, next year) and which multiple (historical average, peers) were used shows how strong the basis is.
• Coverage gaps: small caps often have no reports or only old ones, so the consensus itself may be meaningless.

What to check in buyback and dividend disclosures

In shareholder return disclosures, “how” matters more than “how much”.