My favorite quote from the interview (on how to begin the process of detecting earnings quality issues):
Start with reading the actual financial statements (Balance Sheet, Statement of Income and Cash Flows) and accompanying footnotes for at least two periods and look for changes -- in account titles, accounting principles, estimates. After you have concluded your analysis and evaluation, then read the commentaries found in the MD&A, Letter from the President, other subjective reports by "friendly" sell-side analyst. Also, interview management when you have read all these documents and be alert when management is giving an evasive or untruthful answers.
Before I begin with the recommendations, I think there needs to be a quick point made. While I think that the majority of the accounting disclosure books can be used for shorts, they can also be used to determine if a management team is prudent and conservative. That being said, the books listed below have greatly increased my ability in shorting common e equities (as well as buying protection on a number of issuer).
Many of these books cover the same topics in nature (i.e. growth of sales versus growth of AR), but each presents ideas in a unique spin that I think all investors can learn greatly from. I personally have read each of these books below multiple times and recommend each of them highly. I will give a flavor with bullet points for each of them below:
- Recommended by Blue Ridge Capital's John Griffin to Columbia Business School Students
- The book title spells it out: The book is 100% devoted to short selling and the categories that go along with that: "Bubble Stocks", high growth companies with low returns on capital, companies that can't internally finance themselves
- Unlike the other books below, this book deals less with accounting disclosure and more with the short sale process that a long/short hedge fund might engage in (it is also less technical)
- If you had to read one of the books on the list, I would recommend this one
- Written by Michelle Leder, of Footnoted.com fame
- Very good introduction to basic financial statement analysis and understanding of corporate footnotes
- Michelle does an incredible job at providing a substantial amount of case studies throughout the book
- If you want a quick read to polish up your "accounting gimmicks" skills, I would recommend this one
- Of all books in this post, this one is BY FAR the most comprehensive
- That being said, this book is not for the faint of heart: It is HIGHLY technical and sometimes a very tough read. But, I promise you, you will learn more about "sustainable financial performance" and accounting disclosure than any other book on the list
- This book also does an incredible job at really digging into the cash flow statement and has helped me better understand a company's free cash flow potential
- If you think you are an expert in this detecting earnings mismanagement, and want to further sharpen your skills, I would recommend this book.
- To give you a sense of how much I enjoy this book: I own both the second and third editions, and have read them both multiple times
- Relies heavily on case studies with actual short recommendations from CFRA - I.E. The back their claims up with solid performance
- Very focused on accounting disclosure and management - depreciation rates, AR charge offs, etc
- I very much like Dr. Schilit's writing style which made the book a fairly quick read despite clocking in at ~300 pages
- If you want a deep dive into accounting mismanagement and want a read that is not too easy but not technical, I would recommend this book
- In my opinion: The original book on accounting disclosures and mismanagement. If you have not read it yet, you are really missing something special
- This was the first book I read on "Quality of Earnings" - I have read it so many times that my copy is falling apart. I use it as a reference very often.
- Goes through the major ways a management team can manipulate earnings.
- Delves into some of the intangibles. For instance, there is a whole chapter on parsing a Chairman's Annual Letter that comes with the annual report. While the book heavily relies on number, it also shows you how to think about those numbers in a holistic way.
- For the best treatise on the quality of earnings, I would recommend this book.
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