I think earnings quality is one of the great neglected concepts of investing. Why do many growth investors blow up on seemingly promising companies? The answer is often that the investors did not review earnings quality. Why do value investors fall into value traps? The answer is often that the investors did not review earnings quality.
I have reviewed a number of books, and written many articles about earnings quality Because so much of the investment world is blind here, the idea still has punch.
Thornton O’Glove hits at the subject in a traditional way — accrual accounting entries are always more suspect than cash entries. He focuses on:
- Being skeptical — don’t trust management, analysts, auditors.
- Look for inconsistencies in disclosure. Who tells a happy story broadly, bet is serious in regulatory filings?
- Who plays games with one-time events? What companies push the limits in determining what is a one-time event?
- How do companies play with their accruals in order to report income?
- Is taxable income significantly out of whack with GAAP income?
The book was written in the Mid-1980s, before it was easy to review SEC filings. That has changed, but few really review filings today, even though it is easy to do so.
This is a good book, and you can learn a lot from it, but many of the references are dated, as in the classic version of “The Intelligent Investor.” I mean, I recognize most of the examples, but many readers will say, “Huh, I’ve never heard of that company!”
Do you want to improve your investing? Look to earnings quality.
Who could benefit from the book? Any investor could benefit from the book, particularly those that analyze fundamentals.
If you want to buy the book, you can buy it here: Quality of Earnings
Full disclosure: I bought this book. I review books old and new. This old book still has value, and I recommend it. It will require more effort than most investors are willing to put forth, but I believe it will yield value to those who work with it. This is simple stuff, but it is work, and there is always a barrier to entry around work.
Also, anyone entering Amazon through my site and buying anything — I get a small commission, but you don’t pay anything more. I love it when both my readers and I win.