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Accounting for Value - Stephen Penman


JEast
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[amazonsearch]Accounting For Value[/amazonsearch]

 

With this new effort coming out of the Columbia Business School, I have the belief that Benjamin Graham would be pleased with the achievement. From an investor that uses Graham's work on nearly a daily basis, this is a nice addition to the library shelve.

 

http://www.overstock.com/Books-Movies-Music-Games/Accounting-for-Value-Hardcover/5075838/product.html?refccid=F7W4V6WCI3ILTQSH76D5XQDAUQ&searchidx=1

 

Cheers

JEast

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Agreed! Highly recommended!

Actually, I have used Professor Penman's formula for calculating the PV of equity and posted the results both on the LRE's thread and on a thread about FFH.

Professor Francesco Reggiani of the Bocconi University, who has written many papers together with Professor Penman and got cited in the book, is a dear friend of mine. :)

 

giofranchi

 

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  • 9 months later...

I read this book because of some positive reviews here, but frankly I was quite disappointed. In fact, I didn't even finish it. I guess I was hoping for a different kind of book. What follows is my $.01 review.

 

---

This is a book featuring a lot of math like this:

 

http://www.writser.nl/images/math.png

 

If you just plug in your assumptions for cost of capital, return on capital, growth rate, etc. then this formula will give you the current value of the equity. Unfortunately my investing style is completely different. I mostly focus on the balance sheet. I hardly invest in growth and prefer the back-of-the-envelope 'this is too cheap' stuff that, for example, Nate features on his blog.

 

I was hoping for a book that would teach me something about analysing financial statements from a value-investors perspective. The practicalities of LIFO vs. FIFO, what to look out for with pension liabilities, how to estimate maintenance CapEx, what are the business implications of NOL's, when should I look at the cash conversion cycle, etc. In short, I was looking for a practical book.

 

This is certainly not that book. Instead, this is mostly a very theoretical treatise. The writer explains to me that the 'implied growth forecast' for Starbucks was 9.8% in 1999 based on the numbers. If you think that that is useful then this is your book . I am a bit sceptical about such calculations. If I need them to calculate whether something is cheap I wouldn't buy it in the first place. That said, there are some interesting tidbits in this book, for example the part about expensing R&D.

---

 

I hope the writer isn't a board member :) . If anyone can recommend the sort of book that I am actually looking for then that would be greatly appreciated.  I liked Financial Shenanigans and Quality of Earnings, but mostly these were about avoiding frauds instead of looking at 'normal' companies.

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If you just plug in your assumptions for cost of capital, return on capital, growth rate, etc. then this formula will give you the current value of the equity. Unfortunately my investing style is completely different. I mostly focus on the balance sheet. I hardly invest in growth and prefer the back-of-the-envelope 'this is too cheap' stuff that, for example, Nate features on his blog.

 

writser,

on the contrary I think Mr. Penman’s book is exactly right for the kind of investments you and Nate look for! Mr. Penman warns very clearly about the danger of assuming growth too far into the future, and shows how to use his formula for calculating the present value of equity disregarding future growth. Therefore, that’s exactly right for the kind of investments that suits you the best.

 

Of course, I never look for those investments. Instead, I want something that will grow. That’s why I had to “adapt” Mr. Penman’s formula to my way of investing.

 

But basically I think it would be much easier for you to use Mr. Penman’s formula than it is for me! ;)

 

This being said, I agree the book is not a manual on how to read financial statements, or how to detect aggressive accounting…

 

Gio

 

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Guest wellmont

I read this book because of some positive reviews here, but frankly I was quite disappointed. In fact, I didn't even finish it. I guess I was hoping for a different kind of book. What follows is my $.01 review.

 

---

This is a book featuring a lot of math like this:

 

http://www.writser.nl/images/math.png

 

If you just plug in your assumptions for cost of capital, return on capital, growth rate, etc. then this formula will give you the current value of the equity. Unfortunately my investing style is completely different. I mostly focus on the balance sheet. I hardly invest in growth and prefer the back-of-the-envelope 'this is too cheap' stuff that, for example, Nate features on his blog.

 

I was hoping for a book that would teach me something about analysing financial statements from a value-investors perspective. The practicalities of LIFO vs. FIFO, what to look out for with pension liabilities, how to estimate maintenance CapEx, what are the business implications of NOL's, when should I look at the cash conversion cycle, etc. In short, I was looking for a practical book.

 

This is certainly not that book. Instead, this is mostly a very theoretical treatise. The writer explains to me that the 'implied growth forecast' for Starbucks was 9.8% in 1999 based on the numbers. If you think that that is useful then this is your book . I am a bit sceptical about such calculations. If I need them to calculate whether something is cheap I wouldn't buy it in the first place. That said, there are some interesting tidbits in this book, for example the part about expensing R&D.

---

 

I hope the writer isn't a board member :) . If anyone can recommend the sort of book that I am actually looking for then that would be greatly appreciated.  I liked Financial Shenanigans and Quality of Earnings, but mostly these were about avoiding frauds instead of looking at 'normal' companies.

 

that kind of formula tells me it's not something I could understand. back of envelope for me. :)

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While I am also not a fan of formulas, Penman is looking at things from a purely value perspective (albeit at a GARP sense).  This book is definitely not geared towards a Graham stock, but closer towards Buffet.  He outlines his thinking early in the book to indicate that he targets growth and ways to reasonably value it along with the risks.

 

Either way, it's a bit heavy as there are a lot of formulas, but it helps get his point across.  I read the book and flagged a lot of pages, I enjoyed the book as it was different than most value books that repeat the same things over (although the same things always keep on working).

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I would not use complex formulas while investing, but I also wouldn't skip a book that otherwise seems interesting because it has formulas. I'm currently about 4 chapters in McKinsey's 'Valuation' and it has some formulas too, but they just help support what they're explaining about ROIC and growth, etc. The book has make clearer some things I had been thinking about for a while about business quality, and just for that the book is already worth it.

 

I hope that Penman's book will similarly contain some interesting ideas that I can incorporate in my mental models even if I never use any of the formulas directly.

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Gio: agreed but I usually look for stocks where I can be satisfied with a much simpler calculation. If it's profitable and trading below NCAV I don't need to know the present value of the equity in 3 digits.

 

I agree: if what you are interested in are basically profitable net-nets, the book won’t add much value… the only question you must answer is why a business that’s profitable is selling for less then the value of its net current assets… unfortunately, I think the answer to that question each time is a different one, and each net-net is a case of its own… therefore, I guess no book will be of much help!

 

Now that you made me think about it, I have realized that, although Mr. Penman warns against the perils of relying too much on future growth, probably the greatest usefulness of the book lies in the following: to provide an understanding of how much valuable truly is a business that will grow. ;)

 

Gio

 

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that kind of formula tells me it's not something I could understand. back of envelope for me. :)

 

Don’t get misled… That formula is nothing but a discounted valuation… Mr. Penman’s simple, yet imo interesting idea is to apply a discounted valuation to equity, instead of cash flow… That’s it!

A discounted valuation to understand how valuable a business actually is, that:

1) creates value, in other words that grows at a higher rate than its cost of capital;

2) should be valued on balance sheet metrics (some multiple of its BV or NAV).

Which multiple of BV or NAV best approximates FV? Mr. Penman’s formula provides the clearest answer that I know of! ;)

 

Gio

 

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