Financial statement analysis for price investment. 2025. Stephen Penman and Peter Pope. Columbia University Press.
The discipline of price investment has been a long -difficult time. Tireless climbing passive investment strategies, prolonged performance of development shares since the global financial crisis, and overall assessment in developed markets (where time-tested assessment principles are no longer applied), for name, but some have contributed to their struggles. As a result, successors of Graham and Dod tradition are counted these days and are re-charged for emerging markets or deep-value strategies in Japan. Is it only a temporary disaster, or is the tradition needed some refinement to remain relevant in today’s financial scenario?
Against this background, Stephen Pennman, George O at Columbia Business School. Professor Emeritus, and Professor Emeritus Peter Pope of the accounting at London School of Economics have published the name of 432-page toms. Financial statement analysis for price investmentA task that is strongly linked in Graham and Dod Price Investment Tradition. The book is also spread over the structure developed by Pennman in its 2011 work, Price accounting,
In both books, readers will face classic price investment concepts, such as the importance of dialogue or safety margin with the Mr. Market, and some insight from the modern portfolio theory, such as the company’s capital structure in the neutrality of dividends or the price for shareholders. Physicians will get this amazing and liberal combination of fresh and informative ideas. As the authors have briefly introduced:
You will get a book contradiction with many investment books. Omnipresent beta is not yet the top priority. Normal discounted cash flow (DCF) is placed aside. Indeed, the book is generally doubted about the evaluation model. Perhaps surprisingly, the book takes the position that it is best to think that “internal value” does not exist. For a value investor who looks like heretics, but it is very difficult to pin the internal value. This requires an alternative approach that must be placed on the table, which challenges the market value with confidence. Some investors see the option as trading on qualities, smart beta investment, factor investment, and more. The book criticizes these plans.
So, what do the author offer? The foundation of the book is residual income model. First for the first 1980s[1] And 1990s[2]Late later, compared to other assessment framework, such as dividend exemption models, the residual income model was popularized by the consulting firm Sterns Stewart in the 1990s and was briefly adopted by the management teams of many large American corporations whether their investment decisions were generating value for their shareholders. However, despite several academic letters on the model, its adoption by physicians is limited, the valuation lags behind more widely used approaches such as multiple and free cash flow models.
As a quick refresher, the residual earning model instructs us to think about evaluation through future residual (or economic) income lenses that are expected to be born of a business. Residual earnings are only accounting income after taking into account the cost of capital charge. These future residual earnings should then be returned to the current and added to the current book price of the company to reach the evaluation for equity. In particular, if a company’s return on equity corresponds to its cost of capital, it will generate accounting income but will not have any residual earnings, which means its shares should trade at the book price. The model’s elegance lies in the spontaneous integration of commercial basic things with accounting data, which in turn produces an evaluation for the investor.
Although three valuations framework (dividends, free cash flow, and residual income) are mathematically equivalent, residual income stands out for shareholders’ ability to catch the right sources of value construction. Companies that do not pay dividends or reinverse in dividends or profitable development opportunities will be difficult for value using dividend exemption or free cash flow model, respectable, but they do not interrupt residual income structure.
The reason for this model captures the value construction more accurately (and earlier), which lies in allegations that control current accounting systems. While the so-called “cash accounting” is often favored by physicians on a deferred-cut accounting that the cash is close to “hard and cold facts”, while dishonest management teams can easily manipulate the undertakings, penman and the pope show that this traditional knowledge is only misleading. First, cash flows can also be manipulated by management teams.
Second, there is a pile of transaction that does not include the cash flow, yet moves the value between the stakeholders, probably the most prominent example with stock compensation. But most importantly, earnings are usually recognized first compared to cash flow under “realization theory”. For example, sales are recognized on credit before obtaining cash to the company, depreciation of capital investment over time (increase in earnings at the beginning of investment), and pension obligations are immediately accounted for, even if there will be no cash flow out of the company to pay promises until decades. Important implications for investors evaluating stock in the real world, where the future is uncertain, is “”[w]Ith has added recognition of this first value, an assessment has low weight at a terminal price. ,
In summary, an accounting system and attainment principle based on an accounting system naturally reflects sound thinking about how firms create value for investors, as well as some guidelines to understand the risk and return. The price is capitalized only on the balance sheet when the certainty of investment is high, and later earnings are added to the book value only when they realize. From this point of view, alternative forms of “carrying”, such as fair value accounting, failed to maintain these principles. During the book, penman and pope criticize fair value accounting to encourage speculative behavior by placing uncertain values on the balance sheet, which eventually contributes to the investor speculation – as was exemplary during the dotcom bubble.
The book dedicates several chapters to refine the traditional residual income model, which fails to adequately address the issue of financial length, due to dependence on equity matrix such as book value, net income, and equity. The issue here is that one may think that adding the leverage will generate price for shareholders as a high leverage will promote residual earnings by increasing returns on equity.
As the penman and the Pope explain, however, this line of logic is flawed, as an increase in leverage will increase the risk of investment and thus, discount rates, leave the evaluation unaffected. To solve this, the author introduces residual operating income models, which uses the enterprise value metrics instead of the equity of shareholders, such as pure operating assets, net operating income, and further. In doing so, this model attracts the investor’s attention on the correct source of value construction in any company: the operation of the business.
Finally, the book “Growth vs. Value” leaves some space for debate, a theme Penman himself discovered in 2018 Financial analyst journal paper[3]Also the relationship between firm size and equity returns. Readers will know how a consistent accounting structure and its implications work for its implications, here, go a long way to understand issues at stake. Pennman and Pope argue that simplified and often misleading labels such as “development” or “value” are less in advancing interaction and cannot change the intensive understanding of accounting principles.
Finally, physicians will get the book of penman and pope not only highly relevant but also with invaluable insight. This task separates countless other “investment” from manual, its ambitious objective: offering a series of disconnected anecdotes and a harmonious and alternative structure to challenge market prices. The authors efficiently strengthened the intuition earned by the reader’s hard work, combining theoretical depth with abundant real -world examples. I have no doubt that this book will become a permanent classic in Graham -Dodd tradition and perhaps the holy grave for future generations of intelligent investors.
[1] For example, K. Pisnell, “Some formal relations between economic values and yields and accounting numbers,” see, ” Trade finance and accounting magazine 9, No. 3 (1982): 361–381.
[2] J. Ohalson, “Dividend in income, book price, and equity valuations,” Contemporary accounting research 11, No. 2 (1995): 661–687.
[3] S. Pennman and F. Regionani, “Price vs. Development An explanation for the basic principles and value trap of investment,” Financial analyst journal 74, No. 4 (2018): 103-119.