The Aleph Blog » Blog Archive » Book Review: Accounting for Value

Book Review: Accounting for Value

Before I start this evening’s book review, I would like to ask a favor of my readers.  If you like my reviews, maybe you can say that they are helpful at Amazon.  I rank in the 2000s at present, which was a challenge to get to, because not many reviewers of finance, investing, and economics books get to levels like that.  So, to the degree that you like my reviews, and have extra time to do this, I appreciate it.  If not, no worries — I’ve well exceeded my expectations; I appreciate that you read me.

I have never taken a course in accounting.  But I have had to do accounting for most of my working life, including doing financial reporting inside life insurers, which is the most complex industry for accounting. I have even opined on 10+ financial accounting standards over time.  And Aleph Blog is a leading accounting website as a user of accounting. (Dubious distinction, I know, but when you are a blogger, you take what you can get. ;) )

As a value investor, I have taken a skeptical view toward the accounting of the companies that I invest in.  Cash entries can be trusted; accrual entries are less trustworthy in proportion to the length of time and uncertainty to the collection of cash.

This book relates accounting principles to value investing principles, and it is uncanny as to how they overlap.  It also attempts to connect it to Modern Portfolio Theory [MPT] concepts where it makes sense, but with less success. (No surprise, because value investing has a decent theory behind it and MPT doesn’t.)

The cornerstone of this book is return on net operating assets [RNOA].  The idea is to split the company in two, and separate operating results from financing results.  Give little value to financing results, which are likely no repeatable, and give significant value to operating results.

Note: this means that there is no way of evaluating financial companies under this rubric, but that’s a common problem.  Financial companies are a bag of accruals; value is difficult to discern.  That is why I spend most of my time analyzing the management teams of financial companies to see if they are conservative or not.

The book offers two measures of accounting quality, the Q-score and the S-score.  You would have to do more digging to make these practical, but at least you get some direction in the matter.

There are two simple prizes that the book gives to readers:

1) Profit results mean-revert; don’t trust strong or weak current ROEs. (or RNOAs)

2) Stocks with low P/Es and P/Bs do well.  Each works well, but they work better together.  Maybe if Ben Graham were still alive, he would not have been dismissive of his life’s work at the end, value works.  It’s an ugly brain dead strategy, but it works.



Who would benefit from this book: Those who want to improve their perception of investment value would benefit from this book.  If you want to, you can buy it here: Accounting for Value (Columbia Business School Publishing).

Full disclosure: The publisher asked me if I wanted the book, so I asked for the book and he sent it to me.

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.

Accounting, Book reviews, Portfolio Management, Quantitative Methods, Stocks, Value Investing | RSS 2.0 |

4 Responses to Book Review: Accounting for Value

  1. Pacioli says:

    “(No surprise, because value investing has a decent theory behind it and MPT doesn’t.)”

    Is efficient market hypothesis the element of MPT that you disagree with?

    I would agree (with your disagreement), but just wanted to clarify whether it was that, or some other piece, which is your quibble with MPT.

  2. [...] A positive review for Stephen Penman’s Accounting for Value.  (Aleph Blog) [...]

  3. SteveP says:

    Did the amazon thing and had I known to do it earlier I would have done it back then. I find your reviews most useful so yes I will go back and say so on your other reviews too. great job with the blog BTW


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.

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