Book Review: Value: The Four Cornerstones of Corporate Finance

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.

Quibbles

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.

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