Interview with Stephen Penman, author of Accounting for Value

Accounting for Value

Q. What’s an extroverted accountant?

A. One who looks at your shoes while he is talking to you instead of his own.

The above joke comes from a recent interview on Ideas at Work with Stephen Penman, author of the just-published Accounting for Value. While Penman relishes jokes about accounting, his book argues that many other elements of accounting should be challenged. In the interview, Penman says,

I wrote [Accounting for Value] to expose investors to the idea that rather than pulling the standard set of tools out of the box … investors can extract great value by engaging with accounting and financial statements in the mode of fundamental analysis.

Penman goes on to explain the importance of accounting for investors as he challenges conventional wisdom:

As an investor, I have two choices. I can have faith that markets are efficient and believe that just by holding stocks they will outperform bonds in the long run. That’s what the Church of England did, putting all of its pension funds into stocks and losing most of its money. That is risky. The alternative is to kick the tires, to investigate, pulling information about a company together to get a good look at value. Price is what you pay, value is what you get. There’s a huge amount of information about firms but accounting can pull it together for you. Accounting for value, as the book’s title says.

As for the cost of capital, we should be honest with ourselves and acknowledge that we don’t really know the cost of capital. People grind that idea down Wall Street, but it’s sort of a dirty little secret: we can’t calculate the cost of capital.

But you don’t need to know the cost of capital! Rather than trying to determine it, investors should ground themselves in the accounting and ask, “If I buy at the current market price, what do I expect to earn as a return?” The analogy is to ask, “What is the expected yield to buying a bond at the current market price?” The answer indicates whether an investment is cheap or expensive. But you need some accounting to get the answer, and the book shows how.

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