I had a very good lecturer for my accounting class while at Columbia University. He was a Columbia Business School associate professor who used to work for Arthur Andersen, one of the Big 8 auditing firms. This professor was a big improvement over the previous undergraduate accounting lecturer, a middle-aged woman with a dry teaching style who wore athletic sneakers under an ankle-length dress.
My accounting professor made the subject interesting by stressing how not one single number on any financial statement besides some cash flow figures can be verified. Pretty much everything from balance sheets’ assets and liabilities to income statements’ revenues and expenses is subject to managers’ (sometimes “creative”) interpretation. In publicly-held firms, financial statements are important to shareholders who use them to assess the performance of their investments. This requires management, however, to report financials that reflect reality. In truth, management can use accounting concepts such as depreciation, asset securitization (aka CDOs), and expense capitalization to distort a firm’s performance or just straight-up lie.
So let’s say you have a chunk of disposable income in your pocket, and instead of splurging on the newest tech gadget or Gucci handbag, you decide to invest it in stocks. How do you pick a good one? Bad news: 99% of people have no idea, including all those fund managers who are paid millions in fees to pretend like they know. So, of course, this post won’t tell you how to invest your money, but you may learn what to watch out for. One of the things to be aware of is telling responsible managers apart from false promoters.
I recommend you start by reading The Intelligent Investor by Benjamin Graham, an American economist and the father of value investing. If you get this edition with Jason Zweig’s commentary, you’ll learn that trustworthy managers are those who don’t pander to the investing public or act as “hype-o-chondriacs” spewing glowing press releases. Zweig gives advice such as checking Form 4 on EDGAR, a public, online database of corporate financial information, for repeated big sales of equity by senior executives. If executives don’t put their money where their mouths are, why should you?
Other things to be on the lookout for:
- non-recurring charges that recur consistently
- “extraordinary” items so frequent they become ordinary
- EBITDA that appears more than net income
- “pro forma” earnings that cover actual losses
Although my professor made accounting fun, I think it can be taught in a more exciting way. Think CSI – Forensic Accounting. Begin the class by slapping a transparency of Enron’s 2000 balance sheet on the overhead projector. The professor’s first words to the class: “Can anybody tell me what this is?” A student raises his/her hand and answers, “A balance sheet.”
Wouldn’t that be an amazing course? I would totally take this course.