The Interpretation of Financial Statements

This is an excellent book. I've read all of Graham's books and this book is a must before reading any of Grahams other books. It's not the only book on financial statements that I would get but it is definitely one to add to your library. Below are a couple of other good financial statement analysis books to read before investing or reading Graham's other books. You don't need an MBA or a degree in Accounting to invest like Graham. Walter Schloss was a Super Investor of Graham and Dodd as Warren Buffett quoted saying and Walter never went to collage. Ben Graham primarily focused on the balance sheet. Financial Statements: A Step-by-Step Guide to Understanding and Creating Financial Reports How to Read a Financial Report: Wringing Vital Signs Out of the Numbers

What this book is: The 1936 edition of "The Interpretation of Financial Statements" by Benjamin Graham, the father of the modern academic discipline of financial analysis. In brief chapters with examples, Graham explains different entries you might find on a corporation's public balance sheet, how those assets and liabilities (debits and credits) add up, and what the meaning is with regard to that corporation's financial health. There are occasional glimpses of average figures by industry, but given that they were compiled in 1935, they are more interesting as a glimpse into the past - some things have changed, much more has remained the same. What this book is not: 1. It's not a primer on double-entry accounting. If you really don't know anything about double-entry bookkeeping, you'll find the book rough going, as basic familiarity is assumed. 2. It's not an editorial. There's remarkably little opinion given about how to value companies based on their balance sheet entries. That task is performed in the author's mammoth magnum opus, Security Analysis (I prefer the 1940 edition). This book does function admirably as a tableside glossary to that work. 3. It won't tell you how to get rich by investing. Readers looking for get-rich-quick guides should look elsewhere. 4. GAAP- or SOAP-compliant. Both Generally Accepted Accounting Principles and Sarbanes-Oxley postdated the publication of this book by many years. I enjoyed this book and found it a pleasant, intelligent and necessary introduction to Graham's Security Analysis. If you have interest in learning about the history of financial analysis, you will probably find this book of interest as well.

"In 1984, [Warren] Buffet returned to Columbia to give a speech commemorating the fiftieth anniversary of the publication of "Security Analysis". During that speech, he presented his own investment record as well as those of Ruane, Knapp, and Schloss [other successful investment managers who were students of Graham at Columbia]. In short, each of these men posted investment results that blew away the returns of the overall market. Buffett noted that each of the portfolios varied greatly in the number and type of stocks, but what did not vary was the managers' adherence to Graham's investment principles." It is difficult to encapsulate Benjamin Graham's investing style in a few sentences or paragraphs. Readers are strongly urged to refer to his "The Intelligent Investor" to obtain a more thorough understanding of his investment principles. In brief, the essence of Graham's value investing is that any investment should be worth substantially more than an investor has to pay for it. He believed in thorough analysis, which we would call fundamental analysis. He sought out companies with strong balance sheets, or those with little debt, above-average profit margins, and ample cash flow. (For more insight, see Introduction To Fundamental Analysis and Testing Balance Sheet Strength.) He coined the phrase "margin of safety" to explain his common-sense formula that seeks out undervalued companies whose stock prices are temporarily down, but whose fundamentals, for the long run, are sound. The margin of safety on any investment is the difference between its purchase price and its intrinsic value. The larger this difference is (purchase price below intrinsic), the more attractive the investment - both from a safety and return perspective - becomes. The investment community commonly refers to these circumstances as low value multiple stocks (P/E, P/B, P/S). Graham also believed that market valuations (stock prices) are often wrong. He used his famous "Mr. Market" parable to highlight a simple truth: stock prices will fluctuate substantially in value. His philosophy was that this feature of the market offers smart investors "an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal."

Benjamin Graham (1894-1976) was a pioneer in the field of value investing. He is most famous for being Warren Buffet’s teacher at Columbia Business School. The Interpretation of Financial Statements was originally published in 1937. This 122-page book focuses on the balance sheet and income statement. Graham also wrote Security Analysis, first published in 1934, and The Intelligent Investor, first published in 1949. There are a number of intangible assets on the balance sheet. In the introduction, Michael Price describes an experience early in his career. F&M Schaefer Brewing Company appeared to be trading well below intrinsic value. “I’ll never forget looking at the balance sheet and seeing a +/- $40 million net worth and $40 million in intangibles… I looked in the notes and at the financial statements, but they didn’t reveal where the intangibles figure came from. I called Schaefer’s treasurer [and asked]… He replied, ‘Don’t you know our jingle, Schaefer is the one beer to have when you’re having more than one?’ That was my first analysis of an intangible asset which, of course, was way overstated.” Graham writes about the smoke and mirrors of goodwill. “Many companies which started with a substantial good-will item have written this down to $1 by making corresponding reductions in their surplus or even their capital accounts. This writing down of good-will does not mean that it is actually worth less than before, but only that the management has decided to be more conservative in its accounting policy. This point illustrates one of the many contradictions in corporate accounting. In most cases the writing off of good-will takes place after the company’s position has improved. But this means that the good-will is in fact considerably more valuable than it was at the beginning.” “Patents constitute a somewhat more definite form of asset than good-will. But it is extremely difficult to decide what is the true or fair value of a patent at any given time… The value which the patents are carried on the balance sheet seldom offers any useful clue to their true worth.” “In general, it may be said that little if any weight should be given to the figures in which intangible assets appear on the balance sheet. Such intangibles may have a very large value indeed, but it is the income account and not the balance sheet that offers the clue to this value. In other words, it is the earning power of these intangibles, rather than the balance sheet valuation, that really counts.” It can be insightful to compare figures over several time periods to determine if performance is improving or deteriorating. • “In the working capital is found the measure of the company’s ability to carry on its normal business comfortably and without financial stringency, to expand its operations without the need of new financing, and to meet emergencies and losses without disaster… The growth or decline of the working capital position over a period of years is also worthy of the investor’s attention.” • “Receivables should be studied in relation to the annual sales… and in relation to changes shown over a period of years. If the receivables seem unusually large in proportion to sales, or to other items, there is some indication that an unduly liberal credit policy has been pursued, and that more or less serious losses are likely to be sustained from bad accounts.” • “The most important individual item among the current liabilities is that of Notes Payable. This generally represents bank loans… If the notes payable are substantially exceeded by the cash holdings they can ordinarily be dismissed as relatively unimportant. But if borrowings are larger than the cash and receivables combined, it is clear that the company is relying heavily on the banks… Such a situation may justify misgivings. In such a case the bank loans should be studied over a period of years to see whether they have been growing faster than sales and profits. If they have, it is a definite sign of weakness.” “An abnormally large inventory suggests that a good part of the merchandise may be unsalable and that its price may have to be drastically reduced in order to move it… The chief criterion is the ‘turnover’—defined as the annual sales divided by the inventory… Inventory turnover is important because the more times a year a company can turn its inventory, the less capital is invested in inventory, and there is less chance of loss through obsolete material.” “The book value of a security is in most cases a rather artificial value… Outside of the field of banks, insurance companies, and, particularly, investment trusts, it is only in the exceptional case that book value or liquidating value plays an important role in security analysis. In the great majority of instances the attractiveness or the success of an investment will be found to depend on the earning power behind it.” In a chapter on public utilities, Graham explains, “subsidiary preferred dividends are the dividends paid on preferred stock outstanding in the hands of the public—i.e., not held by the parent company… In dealing with the bonds of public utility and other holding companies, it is usually necessary to consider the subsidiaries’ preferred dividends as fixed charges, for these may have to be paid before there is any income available for the parent company’s bonds.” Approximately one-quarter of the book is a glossary of financial terms. Here are some examples: “Earning Power. Properly, a rate of earnings which is considered as ‘normal,’ or reasonably probable, for the company or particular security. It should be based both upon the past record, and upon a reasonable assurance that the future will not be vastly different from the past. Hence companies with highly variable records or especially uncertain futures may not logically be thought of as having a well-defined earning power.” “Expenditures vs. Expenses. Expenditures are outlays of cash or the equivalent; frequently they involve no concurrent charge against operations or earnings (e.g. Capital Expenditures). Expenses are costs, i.e. charges against current operations or earnings; frequently they involve no concurrent cash expenditure (e.g. Accruals, Depreciation).” “Going Concern Value… The special profit-making character that attaches to a well-established and successful business.” “Good-Will. Intangible Asset purporting to reflect the capitalization of excess future profits expected to accrue as a result of some special intangible advantage held, such as good name, reputation, strategic location, or special connections. In practice, the amount at which good-will is carried on the balance sheet is rarely an accurate measure of its true value.” “Intrinsic Value. The ‘real value’ behind a security issue, as contrasted with its market price. Generally a rather indefinite concept; but sometimes the balance sheet and earnings record supply dependable evidence that the intrinsic value is substantially higher or lower than the market price.” “Joint and Several Guarantee. A guarantee by more than one party under which each party is potentially liable for the full amount involved if his associates do not meet their share of the obligation.” “Junior Issue. An issue whose claim for interest or dividends, or for principal value, comes after some other issue, called a senior issue. Second mortgages are junior to first mortgages on the same property; common stock is junior to preferred stock, etc.” “Leasehold. The right to occupy a property at a specified rental for a specified period of years. To obtain a long term lease at a favorable rental a cash bonus is frequently paid by the lessee to the lessor (owner), if it is a new lease, or to the former lessee, if the lease is taken over. The balance sheet item ‘Leaseholds’ should represent only this cash consideration, and should be amortized over the life of the lease.” “Leasehold improvements. The cost of improvements or betterments to property leased for a period of years. Such improvements ordinarily become the property of the lessor (owner) on expiration of the lease; consequently their cost must be amortized over the life of the lease.” “Protective Covenants. Provisions in a bond indenture, or charter provisions affecting a preferred stock, (a) which bind the company not to do certain things considered injurious to the issue or, (b) which set forth remedies in the event of unfavorable developments. Example of (a): Agreement not to place a lien on the property ahead of the bond issue. Example of (b): The passing of voting power to the preferred stock if dividends are not paid.” “Secular Trend. A long term movement—e.g. of prices, production, etc.—in some definite direction. Opposed to seasonal fluctuations or variations.” “Sinking Fund. An arrangement under which a portion of a bond or preferred stock issue is retired periodically in advance of its fixed maturity...” Michael Price writes, “a stock price must relate to its financials… It is especially common during periods of exuberance or fear that investors depart from the fundamental methods of successful investing… Focus on the fundamentals—how much you are paying for steak and how much for the sizzle—and you shouldn’t go wrong.” Graham concludes, “the investor who buys securities when the market price looks cheap on the basis of the company’s statements, and sells them when they look high on this same basis, probably will not make spectacular profits. But on the other hand, he will probably avoid equally spectacular and more frequent losses. He should have a better than average chance of obtaining satisfactory results. And this is the chief objective of intelligent investing.”

I read this book because it was recommended by Warren Buffett it was a great student of Benjamin Graham. I thought the book was well written and there’s a timeless classic that provides financial guidance that holds true many years after it was written. The author provides a good overview of income statements and balance sheets and important areas to focus on when reviewing company financials.

Classic. Very Concise. And Clear. Written in 1937, but a great deal of it is applicable today. Warren Buffet constantly mentions Return on Tangible Net Assets. This book describes what it is and explains this apporach. Graham might surprise you on his thoughts about Book Value. Book goes item by item on Balance Sheet and then Income Statement, and later ties them together. I am currently studying Financial Accounting and this book solidified what I've learned so far. I used to have a hard time reading Graham, but if you understand that his whole psyche was to concentrate his efforts on the safety of capital, then his writings become very clear. One thing that disappointed me was that Graham didn't cover Treasury Stock(Buybacks), as they weren't common practice in his day.

Nice, simple explanations of key terms and concepts related to Income statements and Balance Sheets. A nice reference to have during your studies. Only complaint is that the book is from an era when Cash Flow Statements weren't standard.

Amazing book that describes the basics of financial statement analysis. It is a historical document but it describes the fundamentals better than any other source.

its so worth the price...

Content remains relevant however print copy is poor! Text print is off, on a angle. Construction is poor, pages separated from binding after first read! Perhaps find the book in another print format, perhaps paper back could be better quality.

Good

Es un librito muy corto y muy fácil de entender. Muy bien estructurado y sencillo. Todavía resulta aplicable para analizar la contabilidad de las empresas. La edición en tapa dura justifica en parte el precio, pero sólo en parte, porque luego el papel y la letra son un tanto deficientes.

Válido para analistas financeiros principiantes que já tenham o básico de contabilidade. Muito objetivo e repleto de insights ainda valiosos. Mas é um livro de 1937 e obviamente a economia, as empresas, a estrutura regulatória e as próprias demonstrações financeiras mudaram muito nesses oitenta e cinco anos. Se fosse um livro longo não recomendaria, mas é curtinho e se lê num final de semana. Importante ressaltar que a análise do autor tem um viés creditício.