Customer Reviews

Quality of Earnings

5 star:		(10)
4 star:		(2)
3 star:		(2)
2 star:		(0)
1 star:		(0)

 

 

"Quality of Earnings" takes a vital approach toearnings analysis--looking beyond raw earnings as spun by companymanagement for "the street". O'Glove covers basics (Chapter1: "don't trust your [sell-side] analyst"), and goes on toincredibly important basics that most individual investors are notexposed to through CNBC and other mass media outlets (includingsell-side analysts' reports). Example: tracking inventory build-up andaccounts receivable levels can make you a lot of money(short-selling--note: this is a very risky practice), or alternatelysave your rear end (if "long-only").

"Shareholderreporting versus tax reporting," has its own chapter--as itshould. I would pay 10 times the price of the book just for thischapter, as the concept is unique as far as I've read.

The CFRA... and various other firms use the same simple concepts in this bookto advise their giant money-manager clients about the quality ofvarious public companies' earnings. Money managers pay many thousandsof dollars a year for research based on the principles offered in"Quality of earnings".

A warning: reading this bookcoupled with listening to public companies' management may lead you toshort selling; if you remain "long only", this book maymerely save your rear end.

"Quality of Earnings" is aimedat those who are willing to devote a little time to research on whatthey own; there are no hard & fast rules in here, just businesscommon sense and insight honed through years of work andobservation.

This book and Schilit's "FinancialShenanigans" remain very close to my heart.

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.

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.

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.

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.

As a novice in the world of wall street, I found this book to be very informative. The differences among "generally acceptable accounting principles" and how they alter the bottom line was a real eye opener for me. The style is breezy and clears up fogs of confusion. The section on dividends is interesting in that the author upholds reasons for companies NOT TO PAY DIVIDENDS. I would like to ask the author about this, since with dividends,an investor gets $ & keeps the stock, while one can't benefit materially from a price increase without selling the stock. Had he explained this, the book would have rated five stars! I hope another volume is in the works...I want to read more like this.

This book describes various ways of detecting deteriorating businesses from reading their financial statements and letters to shareholders. It also gives several examples from the early/mid 1980's. The book is fairly well written and easy to understand, provided you know accounting terms.

The reason I have only given the book a mediocre rating is that parts of it are dated regarding accounting standards, and it is focused on discovering near-term financial problems for businesses but does not really discuss aspects of long-term investing and valuation.

PS: This review is for the 1987 edition which appears to be identical to the 1998 edition.

Thornton O'Glove discusses ways to analyze financial statements and tax data of conpanies:
1. Most analysts have a conflict of interest in that the companies they are analyzing often also have investment banking relationships with the firms that analysts work for.

2. Auditors reports' may not be reliable as the financial operations of even a medium sized business are complex, interpretation of rules are complex and this leaves a lot of leeway in how the financial data is interpreted and reported.

3. CEO's annual letter to shareholders can be compared to their letters from earlier years to gauge how they delivered on their promises and whether or not they papered over their failures.

4. Determining which portions of income are recurring vs. one-time.

5. Differences in reporting for shareholders vs. tax reporting as companies take a conservative approach in tax reporting to minimize taxes.

6. Dramatic growth in accounts receiveable and inventories that is not commensurate with growth in revenue is a leading indicator of channel stuffing.

7. Impact of accounting changes on reported earnings, e.g. FIFO vs. LIFO accounting in manufacturing companies.

8. Tendency for new incoming management to over-proclaim earlier issues, take a huge bath (loss) to clear the decks, and position themselves and the company to do well on a relative basis.

Examples are somewhat dated; focusing on accounting in examples is informative

This is a great book. The most valuable lesson I learned from it is to analyze the differences in income reporting to the IRS vs. reporting to shareholders. All companies keep two types of books, one for the IRS and one for shareholders. There are times when an expense can be deducted from a taxable income on the tax return, but it may not be deducted under the GAAP rules. As an investor, I am interested in knowing what a company reports to the IRS and how this number compares to what it reports to shareholders. Since most of the investors do not even bother to check this discrepancy, the dishonest management may deceive investors by hiding certain expenses.

- Mariusz Skonieczny, author of Why Are We So Clueless about the Stock Market? Learn how to invest your money, how to pick stocks, and how to make money in the stock market

I think earnings quality is one of the great neglected concepts of investing. Why do many growth investors blow up on seemingly promising companies? The answer is often that the investors did not review earnings quality. Why do value investors fall into value traps? The answer is often that the investors did not review earnings quality.

I have reviewed a number of books, and written many articles about earnings quality Because so much of the investment world is blind here, the idea still has punch.

Thornton O'Glove hits at the subject in a traditional way -- accrual accounting entries are always more suspect than cash entries. He focuses on:

Being skeptical -- don't trust management, analysts, auditors.
Look for inconsistencies in disclosure. Who tells a happy story broadly, bet is serious in regulatory filings?
Who plays games with one-time events? What companies push the limits in determining what is a one-time event?
How do companies play with their accruals in order to report income?
Is taxable income significantly out of whack with GAAP income?
The book was written in the Mid-1980s, before it was easy to review SEC filings. That has changed, but few really review filings today, even though it is easy to do so.

This is a good book, and you can learn a lot from it, but many of the references are dated, as in the classic version of "The Intelligent Investor." I mean, I recognize most of the examples, but many readers will say, "Huh, I've never heard of that company!"

Do you want to improve your investing? Look to earnings quality.

Who could benefit from the book? Any investor could benefit from the book, particularly those that analyze fundamentals.