Accounting for Value by Stephen Pennman

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Jul 06, 2011
The focus on abstract concepts of valuation has long been commonly adopted my most as a means of measuring the prospect of profitability of investment by determining the value of companies using methods such as CAPM, cost-of-capital and discounted cash flow analysis. However, such measures or tools have, in some instances, been incapable of predicting certain aspects of the financial world which impacts the accuracy of the valuation. The current market instability, the financial crisis of 2008 and the stock market bubble of the 1990s are some aspects of the financial market which cannot be accurately predicted and taken into account using the abstract concepts that are adopted by most when making financial decisions.


The lack of application of accounting principles when determining the value of the company makes valuation less practical. The book "Accounting for Value" by Stephen Penman introduces an innovative approach for valuation which takes into perspective the various accounting principles which make efficient the process of valuation.


A short bio about the author:


Stephen Penman is George O. May Professor of Accounting[img][img]null[/img] at the Columbia Business School. He is the author of “Financial Statement Analysis and Security Valuation," for which he received a Wildman Medal Award. He also recently authored a book titled "Accounting for Value." The book’s novel approach shows that valuation and accounting are much the same: Valuation is actually a matter of accounting for value. Stephen is also an editor of the Review of Accounting Studies.


The author takes on the task of effectively merging the fundamentalist valuation theory with modern financial accounting principles to more accurately estimate the prospective profitability of the investment. The book redefines the parameters of fundamental value analysis by emphasizing the need and importance of accounting in evaluating risk. According to Penman, the biggest and the most basic risk of an investment is paying too much for a stock.


"Accounting for Valuation" is a must-read for market regulators, investors and academics who require an updated perspective on the investment philosophy of Benjamin Graham incorporated with currently applicable financial models and accounting methodologies.


The first chapter is fully loaded with valuable insight regarding the different methods of valuation along with the elaboration on the 10 primary principles of fundamentalist valuation. The comparison done between the fundamentalist perspective of valuation as put forward by Benjamin Graham and the modern financial methodologies illustrates the importance of accounting to understand the complex financial world of today.


The next several chapters discuss a diverse range of topics concerning accounting, starting with the elaboration of the different tools used for accounting for value. Penman demonstrates through application of his valuation approach by dissecting the speculative component of the market price from the actual share price according to which the growth and profitability is determined. Additionally, he delves into a deep discussion regarding the growth perspective of stocks and addresses some issues that investors face when using the standard valuation model.


Finally, the book presents comprehensive risk evaluation methods which can and should be used for enhanced determination of risks undertaken. Instead of adopting CAPM or similar approaches, Penman puts forward a more realistic method which instead of the discounted rate takes into consideration the market price. According to him, valuation of a company and determination of risk should be based on concrete observable facts and figures instead of predictions or expectations.


In the last few chapters he mentions the reasons for preference of fair value accounting rather than GAAP accounting and logically concludes by introducing a cohesive valuation technique which is consistent with fundamental valuation and does not simply focus primarily on the concepts of modern finance.


"Accounting for Valuation" concentrates on effective ways of valuation which challenges speculation, distinguishes price growth from value growth, and reduces risks of falling prey to behavioral biases. Moreover, the book highlights the drawbacks of modern finance which prevents individuals from correctly assessing value of investment. The revised formula presented by Penman in the book could serve as basis for accounting regulators to introduce reforms which could promote more accurate ways of valuation. In short, Stephen Penman presents an innovative approach to valuation which merges fundamental methods with modern finance and determines a comparatively more accurate value through fundamental analysis of financial and accounting statements of the company.


To purchase the book on Amazon.com click on the following link- Accounting for Value (Columbia Business School Publishing)


Disclosure: I receive free books from book publishers and authors asking me to review them. In addition I sometimes request specific books that look interesting. I try to review the books that I think will be the most interesting. I have a material connection because I received a free copy of this book from the publisher. In addition I receive a small commission if you click on the above link and buy the book (or anything else) from Amazon.com. However, it does not cost you a penny more.


You might want to also check out a guest post which Stephen wrote on my website. The post can be found at the following link-_http://www.valuewalk.com/value-investing-philosophy/benjamin-grahams-accountant/


http://www.valuewalk.com/