Thorton L. O’Glove's 'Quality of Earnings' Provides Timeless Advice for Value Investors

If you’re into value investing, which of the three financial statements do you concentrate on the most?

I tend to perform balance sheet analysis and cash flow statement analysis much deeper than the income statement. I would guess that you do the same.

That’s where this gem of a book, Quality of Earnings, comes in. Thorton L. O’Glove has written an absolutely brilliant investment book for the Do-It-Yourself investor.

The fact that hardly anyone has ever heard of this book cements the fact that you will have an edge after reading this book.

For the Enterprising Value Investor

I first came across this investing book while reading The Art of Short Selling, and if a highly acclaimed fundamental short seller highly recommends a book on financial statement analysis, I’m all over it.

First of all, the book is perfect if you are willing to read, go through reports, write some numbers and do some simple math.

If this sounds like too much work… at least the advice is timeless.

Quality of Earnings

As the title of the book suggests, the main focus is on earnings and the quality behind it.

The first 5 chapters deal with the reason why you shouldn’t trust analysts, auditors, letters to shareholders and disclosures in the annual report.

It’s not just a simple discussion though, consistent with the entire book, the author provides examples galore. He even goes through a letter to shareholders and compares what the CEO said to the actual results.

Now that’s what I call holding your hand and walking you through the details!

Financial Statement Analysis Techniques

Earnings are highly manipulative, especially because the GAAP rules are so broad. This undeniably leads many companies to overstate their earnings through aggressive accounting methods.

Wall Street only focuses on the final EPS that is quoted in the press release and at the bottom of the income statement, but O’Glove leads you through methods on what to look for and the simple math you should perform in order to compare with the previous years.

Ever asked yourself the following questions?

• What should you do with non-operating and non-recurring income?
• How do you analyze the status of a company based on declining or increasing expenses?
• What is the difference between shareholder reporting and tax reporting?
• How do you analyze accounts receivables and inventory?
• How should you analyze debt and cash flow?
• Do dividends matter?
• How do different accounting methods affect the value of a company?

The book will help answer all of the above questions.

Why this is Relevant and Important

The obvious time you ask all the questions about a company is before you purchase it. But the lessons in the book help you to identify the flaws before it comes out in public. This could mean saving yourself a lot of money by selling a deteriorating position.

By examining the difference in growth between raw materials, finished goods and accounts receivables, you will have a good indication that a company will write down its inventory.

Summary

Quality of Earnings is a great book if you want to deepen your understanding of analyzing companies and valuation.

The book may be old but the techniques and advice contained within are timeless.

Comments

[User 234091:]

Jae -

Great book written by a great man. I have known "Ted" for about 6 years, and he is smart, generous and loyal. In short, Ted is the kind of guy you'd like to have as a neighbor or in-law.


Hewitt Heiserman
Author, "It's Earnings That Count" (McGraw-Hill, 2004)

Oct 14 11:26 AM

[Neil Carvin:]

I learned about this book when Michelle at footnoted.org celebrated Ted's 75th birthday.

www.footnoted.org/gold.../

The book is as excellent as Jae says.

Oct 17 02:53 PM

[Jae Jun:]

Neil,

Wish you had told me sooner about the book.
Any other great reads? I know you're very well educated in the accounting and analysis department so your recommendations would be great.

Oct 18 12:54 AM

[User 428493:]

This remains a classic that I frequently refer to in my own work and also on my site, footnoted.org.

When I was doing research for my book nearly 7 years ago, I cold-called Ted after reading his book. Over the years, he has continued to provide lots of advice and to share some of his extensive knowledge. He started out as a mentor, but now I'm proud to also call him a friend.

Over 20 years since its publication, Quality of Earnings remains a classic that any investor - not just value investors -- should read.

Oct 18 08:18 AM

[Value Scouter:]

Two thirds into the book, I have to say this is definitely a gem. Timeless advice, fresh perspective, you sure will have an edge if you do your dd. I am actually using it already to better shape up my portofolio.

Oct 18 10:09 PM

[Value Scouter:]

Thanks Jae for referring the book.

Oct 18 10:10 PM

[Jae Jun:]

No worries value scouter. Good to see people willing to apply the proper techniques of investing

Oct 23 02:07 AM

[mbkelly75:]

Continuing education is so important. There is always more to learn to help yourself do better. Timeless advice and concepts are ALWAYS worth knowing and spending the time to learn. Thank you for letting me know about this book. I will add it to my library.
One site I use to help me with Graham Numbers and financial analysis is:
www.grahaminvestor.com...

The quote will give you (among other things) the Altman Z Score and clicking on "Charts" will give you (among other things) the Piotroski Score. Both scores will let you know a lot about the financial health of a company very quickly. Clicking on "Articles" will help you learn what these scores mean.

Nov 18 07:58 AM