Excellent to learn financial analysis

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	• Quality of Earnings Thornton L. O'glove Free Press, 1998 - 224 pages average customer review:based on 7 reviews view larger image
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highly recommended

Excellent to learn financial analysis

This book is very effective in introducing people to critical financial statement analysis. It helps to have some accounting background though. The material in this book will reinforce a lot of the important financial/accounting concepts that all investors should at least understand before committing to an investment. The author makes the accounting concepts interesting and accessible for most people. In short, the book is a great way to learn/reinforce important financial analysis techniques.

Still worth reading

17 years later and many things have changed. The desire of investors to accurately gauge the stability of the companies in their portfolios remains the same. The incentive of management with stock options to hide the true nature of what the reality of what the company's earnings have been remains strong. Some of the techniques mentioned will be hard to use when companies employ SPEs to hide their true indebtedness and derivative positions mask the Value at Risk. However, many of the technique still have value. The analysis of receivables and inventories can provide insight into the immediate future of the company. The techniques that have lost their clear edge are the debt and write-off analysis. Write-offs are now required by GAAP (although the "big bath" write-offs are still "non-recurring") and SPEs or variable interest entities can obscure debt. It is fascinating in light of Enron, WorldCom, Qwest, Tyco, and Adelphia the stories of companies in the 70s and 80s that were attempting to do the same thing (though often without the fraud). How little man changes through the ages.

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Depends upon the reader's background

I read this book because a Wall Street Journal story referred to it as "the" source for quality of earnings analysis. I was somewhat disappointed with the quantity and quality of new information and analytical techniques, but that's not a knock on the book. I think it boils down to your background. If you're a CFO, Controller or seasoned accountant, there may not be alot of new information here for you. The book may be much better for financial analysts that don't have a strong accounting background but need to be able to determine earnings quality. I personally found Creative Cash Flow Reporting (Mulford & Comiskey) to be more useful. Nevertheless, I'm glad to have Quality of Earnings in my library.

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Financial Rapport

Investors who want to survive need to avoid torpedo stocks - the one's you don't see coming to blow a hole in your portfolio. This requires arming yourself with a healthy skepticism. Your stock analyst may be under pressure not to disrupt investment banking deals with negative reports. The auditor's independent review may be compromised by a desire to secure "fat fees" for a host of additional advisory services. Bottom line: Investors need to trust in their own abilities and do the job of reading corporate reports themselves. Read the annual report and more detailed SEC required 10-K filing. This is the simple message of QUALITY OF EARNINGS. Interpreting trends in accounts receivable and inventory levels from publicly available reports are useful tools to spot problems before they impact a stock's price. This is the author's "most important" chapter and it is as good a discussion as I have seen on the subject. The importance of understanding accounting practice changes and their immediate impact on how earnings are reported is another important matter that gets attention here. We also see why "big bath" restructuring charges that lower the bar for short term earnings growth expectations have become a predictable consequence of corporate acquisitions and CEO transitions. Much of this material will be familiar to readers of more current books on the topic, but O'glove's clear explanations and use of the numbers to support his conclusions are instructive. Because this book was written in 1987 the majority of examples used are quaint at best (e.g., Church's Fried Chicken, Coleco, Adademy Insurance Group, etc.). On the other hand, describing accounting changes at IBM or GE's managed use of tax losses through its Credit Corporation unit (GECC) may resonate rather differently with today's wary investor. A chapter dealing with dividends, the "tender trap", reflects recent, not current, thinking. O'glove's position is that "minimal or no dividends" is the best corporate policy. It is a fair discussion. This has been a general consensus for years because of the issues of double taxation and a conviction that capital can be more efficiently employed in a company's core business development. Currently, in the throes of a bear stock market, investors have sought dividend bearing stocks to hedge market volatility, as a tangible sign of legitimate profits (showmethemoney) when accounting scandals are discovered, and more broadly as way of supplementing retirement income. Preferences change, but one thing is certain. The issue of transparency in the markets is critical to assessing value. This book is an excellent introduction to the topic.

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Middle Markets

Long overdue is a middle market with different rules than those by which the traditional markets must be rated in terms of earnings, and standards, to prevent the wholesale financial shennanigans that took place during the late 90's as VC's funded IPO's and oversold them to the institutional markets. There has always been a very healthy start up market in the U.S. that has yet to be tapped for its vitality, and its uncertainty, that can be just as legitimately traded as NASDAQ and the tradtional market. Defining a method of doing that, and setting it up will provide the U.S. with the vehicle to prevent putting excess pressure on accountants and marketers to whittle away expenses and beef up assets to present healthier stocks than they are to take advantage of the speculatators that most young companies draw. In fact, there should be an entrepreneurial wild mustang market similar to the gold rush vitality that Americans come by so naturally, but apart from the traditional markets that require greater control and stability. Organizing such a market would greatly benefit both the industry, the opportunities for investment, and the many personnel who make their living serving the investment industry and its affiliates. Making such an early trader market by taking advantage of the VC interest in early entrance but allow them to cut out early would help to grow the markets exponentially.

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An indispensable guide to determining how much money a company is really making and for buying and selling stocks without making costly blunders.

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