The Accountant’s Investment Edge
Accountants have nearly all the tools they need to be GREAT investors If only they knew it!
Balance sheets can tell all kinds of interesting stories.
A friend of mine once asked me what I thought of a company he worked with. I did some digging and the next time we met, I asked him: “Is the boss sleeping with his secretary?”
“How did you figure that out?” he asked me.
“Well,” I told him, “according to the latest annual report, a woman whose job description is ‘secretary’ is getting an enormous salary, plus stock options and all kinds of other benefits. IBM could hire a high-powered executive for what she’s getting paid.”
Nuggets of Gold
Not all companies have such scandalous tidbits hidden away in the fine print. But the ability to read a balance sheet and a profit and loss statement—especially if you can read between the lines—is a powerful way to dig up listed companies with hidden nuggets of gold. And just as importantly, weed out the dross.
It was these tools that the legendary investor, Benjamin Graham—author of the classic investment primer, The Intelligent Investor—used to build his fortune. These same tools are major weapons in the armory of his star student, Warren Buffett.
Graham analyzed companies’ annual reports to find stocks that were selling below their intrinsic (or “break-up”) value. He didn’t visit company managements; he didn’t even want to know what products the companies sold; he was only interested in the numbers.
Of course, there is a danger in this approach. Often, a company’s stock is selling below its net worth for very good reasons. Maybe it’s just because the market has hammered it down. But perhaps the industry is in decline, the management is incompetent, a new competitor with a superior product is decimating the company’s sales . . . there are a host of possibilities.
By solely relying on annual reports, Graham had no idea why a company was cheap. So he could—and did—buy stocks that declined, taking a loss.
Nevertheless, his investments returned profits of 17% a year, on average, over several decades.
How did he achieve this when, clearly, some of the stocks he bought turned out to be dogs?
He bought a large number of cheap stocks, knowing that while he’d lose money on some of them, he’d make more money on the rest.
To help ensure that outcome, he’d only buy companies with histories of steady management, rising profits and regular dividends. All information you can find in annual reports.
This would weed out many (though not all) of the companies that were cheap because they deserved to be.
And he had another, crucial rule: he would only buy a stock selling for less than half its liquidation value, which he called his “margin of safety.”
While Buffett and Soros have highly concentrated investment portfolios, Graham’s strategy was concentrated in a different way: though he owned many stocks, they were in essence identical—all significantly below their liquidation value.
Stocks like that are a lot harder to find today than they were in the 1930’s, 40’s and 50’s when Graham was active. But not impossible: Walter Schloss, a contemporary of Buffett’s who was also a Graham disciple, continued to follow Graham’s style with great success until he retired in 2002 at the age of 85.
Clearly, mastery of an accountant’s tools are essential for anyone who wishes to successfully invest in stocks.
But if that is all you needed, you wouldn’t be able to hire an accountant for love or money. They’d all be sunning themselves in the south of France watching their investment profits roll in.
So why haven’t more accountants retired from keeping other people’s books in favor of “clipping their own coupons”?
Two main reasons.
Few of them realize that unraveling the secrets hidden in an annual report is an essential talent for anyone who wants to identify a great investment—and that they already have all those necessary skills at their fingertips.
But—to turn those insights into market profits also requires a complete investment system: a method or a set of rules that tells you what to do once you’ve found an investment that looks promising.
And as for those of us who aren’t accountants and (let’s be honest) don’t want to be?
After all, our real interest is not accounting but investment valuation. So why not start with the man who so applied all these “accounting” tools to valuing investments so successfully: Benjamin Graham and his classic, The Intelligent Investor? After which you might consider “graduating” to his Security Analysis.
No need to reach for any of those dry and dusty accounting textbooks after all.