I was pleasantly surprised by this book. Given the nature of the authors, for McKinsey & Company, I was predisposed to dislike it. But I liked it.
What is the value of a corporation? It is the value of the free cash flows discounted at the cost of capital. That’s basic. And yet, they unpack this simplicity into basic elements, without going overboard into a ton of detail. Value derives from:
- Return on invested capital
- Revenue growth
- Cost of capital
But value does not derive from growth in EPS. I think that Peter Lynch brainwashed a lot of investors, and made them think that growth in EPS is everything.
What this book suggests is a need to unpack accounting statements to get a sense of whether value is being created or not. Following the income statement is not enough; reviewing the level of accruals on the balance sheet helps a lot.
There are many things that don’t affect value:
- Capital structure
- Earnings management
- Accounting rules
What does matter is finding new products and processes that change the value of the future free cash flow stream.
They spent little time on the cost of capital. They could have done more there. That may seem small, but given all the errors that have occurred there, particularly from those that took on too much debt, it would have been valuable to spend more time guarding against aggressive liability structures.
Who would benefit from this book: Most investors would benefit from this book a little. If you are familiar with the arguments, as I am, there is no benefit. If you are inexperienced, the book is probably too advanced for you. Those who would benefit the most have moderate experience with fundamental investing.
If you want to, you can buy it here: Value: The Four Cornerstones of Corporate Finance.
Full disclosure: The publisher sent this to me after asking me if I wanted it.
If you enter Amazon through my site, and you buy anything, I get a small commission. This is my main source of blog revenue. I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip. Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book. Also, I never use the data that the PR flacks send out.)
Most people buying at Amazon do not enter via a referring website. Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites. Whether you buy at Amazon directly or enter via my site, your prices don’t change.