Quality of Earnings

Now in 2014, this book is nearly 30 years old. The author probably never anticipated that all financial statement analysis could be quantified and available for FREE on the Internet. However, the simple lessons the book offers are timeless because of the clear message: The GAAP rules are flexible enough to allow companies to present earnings data in a favorable light without bending any of the rules. Below are examples of the healthy skepticism championed by the author that continue to be relevant 30 years later.The chapter dealing with Non-Recurring Earnings asks what should be done with Investment or Interest Income, are they part of operations or are they not? -- O'glove teaches how to look at earnings from Major Retailers and find that on 24% came from income other than what was sold in stores, and then poses the question about whether this should be included or excluded from the Bottom Line when analyzing whether the company is a good investment.The chapter dealing with items on the Balance Sheet, particularly accounts receivables and inventories. O'Glove teaches to look inside the inventory balance and find what contributes to that number, and analyze whether that inventory balance is due mostly to finished goods sitting on shelves, signaling future problems with slowing sales or write-offs. O'Glove uses the example of Apple under John Scully in 1985, when its finished-goods inventory nearly tripled from the prior year and Scully explained the subsequent rally resulting from better inventory turnover.The chapter on Dividends and Share Buybacks explains how increasing a dividend payout can subsequently lead to a worse return for shareholders than if the company performed share buybacks of common stock. The illustration of Wester Union is an example of companies becoming locked into paying dividends rather than a more efficient return to shareholders.BOTTOM LINE: O'Glove teaches an analytical approach that requires work, but applying these lessons properly can make the difference between investing in the next WorldCom or the next Apple. Fortunately, O'Glove lessons have been converted into an Excel Spreadsheet by engineer Jae Jun at his Old School Value (OSV) website. The financial statement data comes directly from Morning Star, the proprietary algorithms are 100% transparent and all the tools focus on finding out what happens at the Publicly Traded Company Behind the Scenes. Once you become familiar with the Spreadsheet, modify to fit your needs, observe whether companies use GAAP tricks to brighten their earnings ... All this automated into a Spreadsheet that cuts down analytical time to 10 minutes at the most, allowing you to save time and read the Annual Report footnotes of worthwhile companies.

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.

Very good book for anyone wanting to step up their ability to analysis companies' financial statements. It is for the fundamental investor and gives good detail and tips for any future Warren Buffets.

The beginning of the book was rather slow, but later on the author explains in clear language were to look for in the annual reports.

The book provides framework for analyzing quality of corporate earnings. The author, Thornton L. O'Glove has explained various tools for analyzing corporate earnings reports, both annual and quarterlies. The topics covered include Shareholder Letter, Differential Disclosures, Non-operating and Non-recurring Income, Declining and Increasing Expenses, Shareholder Reporting and Tax Reporting, Key Ratios for Accounts Receivables and Inventories, Debt and Cash Flow Analysis, Understanding Accounting changes and Restructuring. There are numerous practical examples explaining the concepts. Some of these are in the nature of brief case studies. The book is a bit dated as it was published in 1987. But the framework and tools provided are equally useful at present. All painstaking investors will find the book extremely useful and will be able to apply the techniques explained therein in their investment journey.

In my view, the author mastered to collect the major pitfalls of random investors in this very book. I would agree to every statement except of the conclusions of 1.5 chapters, namely the dividend and the operating cashflow.In this book, I understand the author in a sidenote of saying that the OCF can easily be tricked. I totally disagree with that view if I understood him correctly. I much more agree to him when he states in several chapters before and afterwards that it's usually the P&L parts that are interpreted and acted upon as creatively and as weirdly as possible (which is legal). He indicates, too, that it's the cash flows that are seldomly if ever affected by these measures. That's more of a view that I can share.The other chapter that I would like to discuss with the author after having read his book is his opinion on dividends. In parts, I agree with him. He basically concludes that stock buybacks are much more meaningful and profiting (which is true) and that boards shouldn't start dividend increases that future or current CFOs can't pay. This is true. But I disagree with him on the (general) negative implication of dividends. Take Nestlé as an example. If you invested in Nestle in the 80s you would get 100% of your invested capital as annual dividend - every year! There was also a negative example mentioned of a company increasing its number of outstanding shares by more than 60% which increased its dividend consistently and suddenly couldn't pay it anymore. In this case, I would rather see the dilution of shares as the problem and not the dividend. This case would have resulted totally different if the company had kept its number of shares consistently.Coming back to my review for beginners, I'd share the opinion of another recensent: This book should be a must-have for investment beginners. Without this huge amount of collected knowledge, some of us traders wouldn't make the money we make. As an investor you have substantial success if you master the tools that others (out of conformity or lack of knowledge) aren't capable of. Being conscious about the recommendations given in this book is a moat for newbies!I would call myself a fundamentalist. That's why many topics were clear to me. I also use the same principles as the author for stock picking so I was very happy to be confirmed on my way.For newbies: Grab that book and take notes! You'll learn an incredible lot in this masterclass of financial statement analysis.

I have never heard about this book, until Amazon recommended it to me. It sounded interesting so I ordered it, and I’m overwhelmed by how good it is. If you make your investment decisions based on the data from financial reports, this book is a must read. It shows the reader how companies can make you believe wrong or overly optimistic things and also goes into very deep depth about some important yet mostly overlooked fundamentals, like inventory. It also shows you how you can see through the blur of accounting tricks and get a better and more complete picture of the real financial situation of a company. How is this not a classic that gets quoted in almost every newer investment book. If you’ve read The Intelligent Investor this book is the next step down the road…