Creative analysis
Posted on October 11, 2007 by Richard Beddard
Filed Under Investing |
It’s not just accountants that are creative, investors can be too. A not so new book shows you how.
Having read a few, I’ve come to the conclusion books on financial accounts aren’t meant to be read through, unless you’re the sort of person that likes reading dictionaries, telephone directories and parts-lists.
Sadly, another thing I can’t read like a novel, is a company’s accounts, although it’s coming - especially for smaller companies. Whether I’m writing an article or buying a share the Annual Reports are essential.
I use them to check the statistics on websites and investment research, to calculate unpublished ratios, and to tie the numbers in the financial statements together with the words of management to tell the company’s story.
Despite reservations, I was without a book to read last week, and, short of options, I picked up Bob Vause’s ‘Guide to Analysing Companies’ (£20, 2005 - Profile Books). It was shockingly readable - a minor classic. To think it’s been lying in my bookshelf for two years, occasionally flicked through, never opened with intent.
Its readability is partly because the author has a light touch, and it’s partly because he’s happiest tearing up the presentation of the accounts and reassembling it in a style that tells you how the company made it’s money, and how strong its finances are. Some examples:
- The Value Added Statement - a re-jigged profit and loss account - shows how the loot is divided between the internal and external interest groups, the usual suspects: shareholders, suppliers, employees, the taxman and banks.
- The Du Pont pyramid knits together various profit and loss and balance sheet ratios to provide an overall view of profitability: how the return on total assets is derived.
- The Z-score is another collection of ratios that predicts bankruptcy with some success. Peter Temple will explain it in detail next week on the Interactive Investor mothership.
It’s not a funny book (actually there is a funny bit in it about the changing photographs of board directors). It’s not for Dummies. There are no cartoons (except on the cover). And it doesn’t pretend things are easy that aren’t. It doesn’t need to because the way Mr Vause explains accounts, they’re not that difficult.
His way, analysing company accounts is more like a puzzle than a chore and analysts can be as creative in interpreting them as dodgy accountants sometimes are in fiddling them. The final chapter encourages readers to construct their own indices of financial indicators to rate a company, a guilty pleasure I have long enjoyed.
If you’re already familiar with company accounts but feel a bit jaded, this book may surprise you. I’m undecided whether to recommend it for beginners. I still like Michael Brett’s ‘How to Figure Out Company Accounts’, but I wouldn’t want to deprive any investor of the ‘Guide to Analysing Companies’.
Footnotes:
- Peter Temple has also written a book on accounts, ‘Magic Numbers for Stock Investors’, although, because of the way it’s organised (by ratio) it fits more easily into the reference niche. The three of them make a pretty good combination.
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