03.13.08
Posted in All Categories, Book Reviews, Fraud at 9:26 pm by Michael Goode
I have many great things to say about Tracy Coenen, who is a blogger, author, and above all, a forensic accountant. I love her blog and I find her to be witty and intelligent. As a short seller I am also something of a fraud connoisseur, so I appreciate what she does. I eagerly anticipated her first book, Essentials of Corporate Fraud. She was kind enough to let me review before it was published, for which I thank her.
Here is the synopsis of the book from the publisher:
The book guides executives, managers, attorneys, and auditors through the basics of corporate fraud. In order to effectively fight fraud, it is important to understand who commits fraud, why they do it, how they do it, and how it affects the company as a whole.
Essentials of Corporate Fraud is more than a primer on fraud detection and prevention. It is a real-world look at how fraud occurs from an expert who has investigated hundreds of internal frauds, including embezzlement, financial statement fraud, investment fraud, bribery, and corruption. Tracy’s broad experience ranging from law enforcement to traditional auditing and finally to forensic accounting and fraud investigations brings a unique perspective to this publication.
To describe my overall impression of the book I find that I must resort to analogies. The book is like Michael Jordan scoring 18 points or like me only making a 20% return on a stock I have sold short. It is good, and a worthy read, but it is not great. I had expected better. However, I did find the book to be a worthy primer on fraud. There are of course a couple reasons that the book did not live up to my expectations, neither really Tracy’s fault: the book appears to be geared towards management types and it is an introductory book.
While being president of a small company, I am decidedly not a management-type; in fact, I would say that my IQ is about 2 standard deviations higher than the IQ of most managers (or at least people who read management books). The other problem is that this book is an introductory book. To someone who deals with messing up financial statements on a weekly basis (as bookkeeper of my company) and analyzing them on a daily basis (as a short seller), I am already familiar with many ways to defraud.
Despite not being wowed by the book, I found it to be a solid introduction to fraud. It was easily readable, not repetitive (unlike most books geared towards management), and it got me thinking. This book made me reconsider certain ways that my small company operated. Since reading it I have made changes to reduce the risk of fraud. For a book such as this, the best compliment is to say that it was useful, and this book was a useful read for me.
While this book would be useful to many, it is decidedly not useful (nor does it pretend to be) to investors who only care about financial statement fraud. If you are a CPA, manager, or business owner who is not an experienced fraud fighter, this seems to be a good place to start, so you should buy the book.
Whether or not you buy the book I definitely suggest reading Tracy Coenen’s Fraud Files Blog.
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02.13.08
Posted in All Categories, Book Reviews, Personal Finance at 4:03 pm by Michael Goode
Okay, well it is not my book, but I co-authored a chapter. Plus, it is an interesting book. Are We Free? Psychology and Free Will
gives the opinions (and research) of some of the world’s top psychologists on whether (and how) humans have free will. I have not read any chapter but my own, but I am familiar with many of the authors, and their research is intriguing and sometimes disturbing. If you have ever wondered whether you were truly free, this book will be of interest.
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01.12.08
Posted in All Categories, Bonds, Book Reviews, Stocks at 9:32 pm by Michael Goode
John Burr Williams wrote The Theory of Investment Value as his dissertation. First published in 1938, this book is one of the classics of investing. I will not say that the book is a fun read, for it is not. It is dry and difficult. Half the pages are filled with equations. However, this book was a landmark and it remains relevant. This book is far too large and detailed for me to describe in detail, so I will present but a few of the highlights.
John Burr Williams invented the dividend discount model of stock valuation. Previous economists and stock analysts had only guessed at what the proper P/E valuation was for a company or what the proper dividend yield was. Also, most previous analysts ignored the sustainability of the dividend. In his book, Williams made the point that a company could be valued by calculating the present value of the future dividends (discounting those future dividends at the risk-free interest rate).
However, companies sometimes pay dividends that are unsustainable or that are below their true dividend-paying ability. Williams thus showed how to calculate the sustainable dividend payout. This is also known as owner earnings—it is a measure of the earnings after subtracting necessary reinvestment.
Williams also shows that this can be applied even to companies that do not pay a dividend. He made the point that a company increases in value once it has made money, and thus dividends are not necessary (the stock will increase in value proportional to how much would have been paid out in dividends). (As history has since shown, though, companies that do not pay dividends tend to do worse than those that do, simply because they may reinvest the money unwisely.) Williams thus laid the groundwork for what has later become discounted cash flow (DCF) models of valuation. For some types of companies, dividend discount models are still useful today.
Besides this, the last section of the book is a series of examples, ranging from Phoneix Insurance to GM and US Steel. Even if you only read this section, the book is worth the price. The problems facing investors 70 years ago remain today. We would be wise to learn from the past. By all means buy this book and read it.
Disclosure: This article was originally written two years ago and published elsewhere.
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01.09.08
Posted in All Categories, Book Reviews, Stocks at 9:50 pm by Michael Goode
I could have spent a few pages extolling the virtues of David Dreman and his book, Contrarian Investment Strategies: The Next Generation. Fortunately for you, I did not do that. Instead, I tell you simply to buy the book. It deserves a spot on your library shelf adjacent to Ben Graham’s Intelligent Investor. It is one of the most important investment books you will read. In the book, Dreman discusses at length the problems with estimating future earnings and psychological impediments to effective investing. He also lays out the key reasons why value investing works so well and he gives much data that support his arguments. Much of the data in my forthcoming article on regression to the mean is taken from this book.
Buy this book.
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01.05.08
Posted in All Categories, Book Reviews, Stocks at 8:49 pm by Michael Goode
I just finished John Mauldin’s new book, Just One Thing. It took me only two days to read. I cannot enthusiastically recommend this book even thought there are some nuggets of wisdom in it. In the book, twelve investment writers each give their one best investment idea.
Some of the authors rambled and others (Bill Bonner, George Gilder, John Mauldin) did not have anything useful to say that you could not have already picked up from reading Mauldin’s email newsletter or other sources. For those who are not familiar with Dennis Gartman, James Montier, Gary Shilling, and Richard Russell, their chapters make good reading.
The two best chapters were Ed Easterling’s chapter on the capital asset pricing model (CAPM) and its faults and Rob Arnott’s chapter on non-market-weighted index investing. Easterling does a good job of explaining problems with how we look at risk. Arnott makes a good case for avoiding index investing in market-weighted indexes such as the S&P 500. In a market-weighted index, companies that are selling above their true value will be overweighted while companies that are selling below their true value will be under-weighted.
The solution is to invest equal amounts in all different companies. By investing equal amounts in the stocks in the S&P 500, you can average a return of 2% more per year over the market-cap weighted S&P 500. Of course, that is what investors in individual stocks should do. By putting the same amount of money into each stock, regardless of market-cap or price, investors lower their risk while increasing our returns.
Overall, Just One Thing is a decent book and a quick read. Consider buying it.
Disclosure: This review was originally written two years ago and published elsewhere.
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08.31.07
Posted in All Categories, Bonds, Book Reviews, Stocks at 9:20 am by Michael Goode
It was Ben Graham who taught me how to invest. Sure, I had played around with stocks before him, but I didn’t really know what I was doing. His book, The Intelligent Investor, is a one-book course on investing by understanding value.I recommend (and link to) the most recent edition, which has the 1970 edition of Graham’s writing, plus a 2002 commentary by financial writer Jason Zweig. This swells the book to over 600 pages, but it is all useful. I will try to outline below a couple of Graham’s key points.
The most important point that Graham emphasizes is that because we cannot accurately predict the future, we must have an adequate margin of safety. That is, we do not buy a company when it is fairly valued, because there is no room for error. Rather, we buy a stock that is very undervalued; even if the business starts to do a little worse it will still be a great value.
There are two ways we can look at value in companies. We can look at value from the viewpoint of the present value of the future earnings of the company or we can look at the present value of the assets of the company.
Graham liked to buy companies that were trading below 2/3 of their net tangible asset value. You calculate net tangible assets by subtracting all the debts of a company from all ‘hard’ assets, such as cash, receivables, investments, property (while ignoring goodwill, patents, and other hard to value assets).
In buying a company trading at a fraction of its tangible asset value, we are in essence buying it for less than its assets; theoretically, we could close the company and sell off its assets and make a decent profit.
Graham was not usually looking to do this, but in buying a company like that, he knew that its price could not fall much further–if it did, someone would buy up a majority of the company and sell off its assets for a profit. This gave the investor a very small downside risk but a lot of chance for a large profit on the upside.
Companies selling for less than their assets are rare nowadays, although if we wait until the next bear market, we will be able to find some and profit from them. In the meantime, though, we will most often buy companies that are undervalued in terms of their earning potential.
Another important point that Graham made is that, for an intelligent investor, there should be no difference between ‘growth’ and ‘value’ investing. If a company is increasing its earnings at a rapid pace, then its present value will be higher than a company that is not growing.
Thus, a rational value investor will be willing to pay more for a fast-growing company than for a slow-growing company. The problem with most so-called ‘growth’ investors is that they are willing to pay so much for stellar growth that they are left with no margin of safety. During the internet stock bubble, companies such as Yahoo (YHOO: $16.32 -1.27%, market cap: $22.851B) and Amazon.com (AMZN: $131.82 -1.32%, market cap: $58.600B) sold at astronomical P/E ratios. If you had bought Yahoo in late 1999 and held until today, you would have lost over half your money. Buying Amazon would have netted you a small loss–better than Yahoo, but not good considering it has been 8 years since 1999.
Even today, with P/E ratios of 44 and 108, these companies are not cheap. Most likely holding them for the next few years will not be a great investment.
While a company with a high valuation may continue to grow impressively, if its growth starts to slow even a bit, the stock will get hammered. This is why we stay away from overvalued companies, no matter how good they are. There is just too much risk.
Well, in one page I cannot do Ben Graham justice. Buy his book. If you buy only one investment book, this should be it.
Disclosure: I am neither long nor short any of the stocks mentioned above. I own The Intelligent Investor. See my disclosure policy.
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