To fully grasp a company's position, its financial statements are not enough. Consider CVS Caremark (CVS), a provider of prescription and related health services in the US. Nowhere on its balance sheet (or any other of its financial statements) would you find its guarantees for certain former subsidiaries, but these guarantees have turned out to be very real. In its last quarter, the company took an $80 million charge that would have caught off-guard anyone who had not read the notes.
This is an excerpt from the notes to its 2007 financial statements that would have helped an investor willing to do his homework:
Between 1991 and 1997, the Company sold or spun off a number of subsidiaries, including Bob’s Stores, Linens ‘n Things, Marshalls, Kay-Bee Toys, Wilsons, This End Up and Footstar. In many cases, when a former subsidiary leased a store, the Company provided a guarantee of the store’s lease obligations. When the subsidiaries were disposed of, the Company’s guarantees remained in place, although each initial purchaser has indemnified the Company for any lease obligations the Company was required to satisfy. If any of the purchasers or any of the former subsidiaries were to become insolvent and failed to make the required payments under a store lease, the Company could be required to satisfy these obligations.
Since the writing of this note, Linens 'n Things has gone bankrupt. As such, CVS owes money as described by the note above. The payments CVS must now make will not bankrupt the company; however, the lesson is one that can apply across all companies in an investor's portfolio. As such, these guarantees must be factored into an investor's valuation.
Often, a company will have financial obligations for which it is difficult to determine the precise amount that will have to be paid. In many cases, such obligations are completely omitted from the financial statements, as we saw here with CVS. For this reason (and others that we've described here), it is imperative that investors read the mandatory notes that accompany a company's financial statements.