B8022 Spring 2024 ACCOUNTING FOR VALUER

Java Python ACCOUNTING FOR VALUE

B8022, Spring, 2024

REQUIRED PREREQUISITES AND CONNECTION TO THE CORE

This course builds on material in Financial Accounting and Corporate Finance core courses and complements courses on equity investing in the Value Investing Program and elective courses on fundamental analysis in the Accounting Division. Capital Markets is a co-requisite, that is, it must betaken at the sametime or before this  course. Material from the Managerial Economics and Strategy Formulation core courses is also relevant but not required. Students should have a reasonable understanding of financial accounting principles, the balance sheet, income statement, and cash flow statement, along with the basic principles of finance.

COURSE DESCRIPTION AND OBJECTIVES

The courseworkson basic value investing principles: Price is What You Pay, Value is What You Get; The Primary Risk of Investing is the Risk of Paying too Much; Beware of Buying Growth, for Growth is Risky.

But the course has a particular emphasis: How does the investor handle the accounting information about fundamentals in value investing? How does she infer value from such numbers as earnings, book value, cash flows, return on equity, and return on assets? What are the pitfalls? When can he be led astray? How is accounting handled to understand the value generation of a firm understudy?

The answers to these questions require, first, an understanding of the integrity of the numbers that financial statements report and, second, an understanding of what a “clean” number tells us and what it does not tell us. The first question is the issue of so-called “earnings quality.” While we will be sensitive to the quality of the accounting in this course—and indeed develop some striking criticisms and make adjustments—our focus will largely be on the second, the issue of appreciating the value implications of accounting numbers. (There is a detailed course on earnings quality at Columbia Business School, Fundamental Analysis and Earnings Quality, B8008.)

Accounting numbers, used appropriately, are powerful aids to the value investor in understanding a business and the value in that business. However, they can be easily misused. A P/E ratio, for example, serves as an important input to a value investor, but the investor is in danger of being falsely cued if he or she does not appreciate what that ratio captures. A too-simple form. of “value investing” trades on P/E and price-to-book (P/B) under the label, “Value versus Growth” investing, but the uninitiated is in danger of falling into the Value Trap. In this course, you will understand the Value Trap and how to avoid it. More importantly, you will appreciate how a dedicated approach to value investing handles accounting numbers to understand when price is different from value. Indeed, the course will show how to bring the appropriate accounting numbers together to challenge the market price and thus avoid the greatest risk in investing, the risk of paying too much.

In the course, accounting is dealt with as part of business analysis which is, after all, the prime focus in value investing. We learn about the business via accounting numbers if they are handled appropriately. We’ll apply accounting measurement to understand value added in (prospective) mergers and acquisitions, restructuring of operations, and other corporate strategies.

With an understanding of how accounting connects to value, the investor is ready to engage in “accounting arbitrage.” If the market fails to understand the subtleties on the accounting, that provides an arbitrage opportunity for the insightful investor. Benjamin Graham’s “intelligent investor” is an intelligent accountant. He or she knows how to account for value.

The course title is that of my book, Accounting for Value. This easy read develops the themes and the course flushes them out. That is with the help of a new book, Value Investing By the Book. By the end of the course, you should have the answers to the following questions:

•    How do I understand the profitability of a business from the financial statements and what does that imply for the value of the business?

•   Apple Inc. trades at a forward P/E of 26.5. What does that tell me? Is the stock too expensive? What do you make of Amazon’strailing P/E of 71.7 after a price increase of 49% over the past 12 months?

•   Apple Inc. trades with a PEG ratio of 2.4. Is it cheap or expensive? A PEG of 2.5 for Amazon? Which stock is more attractive?

•   The value investor is said to “anchor on the fundamentals” and eschew speculation. How does one establish an anchorage using the financial statements?

•    Benjamin Graham saw investing as a matter of “negotiating with Mr. Market.” How do the financial statements become part of that negotiation…to argue with Mr. Market about the price?

•   The value investor is wary of taking on leverage. How does leverage affect accounting numbers such as earnings and return on equity, and how can those levered numbers lead me astray?

•   The value investor is wary of buying growth, for growth is risky. How does the accounting tell me that prospective growth is risky?

•    How do I use accounting numbers to understand the growth expectations built into the market price?

•   What is the Value Trap? How can I avoid it?

•    In sum, how do I challenge the market price using accounting numbers? How do I use accounting numbers to avoid the “risk of paying too much” for a stock?

THE TEXT FOR THE COURSE

The primary text for the course is:

Penman, S. and P. Pope. Accounting for Value: Financial Statement Analysis for Active Investors.

This book is in production for publication about May 2024. A prepublication copy is a on the Canvas page for this course.

Further reading is in the following books:

Penman, S., Accounting for Value (Columbia University Press, 2011).

This book is written largely for practitioners, introducing and illuminating the issues

addressed in the course. Read the Introduction and the first two chapters of this book before  the class begins, then follow the book as an introduction to the topics as the course proceeds.

Also available in Chinese, Japanese, and Korean.

Another detailed text is Penman, S., Financial Statement Analysis and Security Valuation, 5thed. (Irwin/McGraw-Hill, 2013). 

The international soft-cover version is the same material as the U.S. version (with a different cover), but much cheaper. It is also available in Chinese, Japanese, Korean, and Portuguese.

You might also look at English, J., Applied Equity Analysis (McGraw-Hill, 2001) for a book that also handles accounting numbers inequity valuation.

CLASS FORMAT

This cl B8022, Spring, 2024 ACCOUNTING FOR VALUER ass requires in-person attendance, with video recording only on special request. Class sessions will revolve around power point presentations, short exercise examples, and longer case discussions. Students are expected to participate actively in class discussions and cases. Beware: Your professor likes to talk, so challenge him with comments and questions. Students will receive a complete copy of notes for each class on Canvas, along with advance case material for subsequent classes. Students should come to class well-prepared to discuss issues and push for the resolution of these cases. Complete solutions to the cases will be posted to Canvas after we have worked the cases in class.

METHOD OF EVALUATION

Course Project	50%
Final Exam	50%

The final exam will be a 90-minute exam in the final class session, open book.

Course Project

There are two alternatives for the course project:

1.   Take one (or more) of the cases we worked in the course and flush it out more fully, applying it to a larger number of firms or expanding on the issues to get more insights.

2.   Evaluate investment in a particular company or sets of companies under a title something like,   “Challenging the Market Price of Company X Using Accounting Information” (you choose the X).

The project can be done individually or in groups up to four people. It should be no more than 15 pages in length (exclusive of an appendix with detail on calculations involved). The submission will be graded on its creativity, depth of understanding, rigor, and clarity in communication. Write it as if to a client whom you are advising, not to a professor. It must be original work.

The project is due May 7, 2024. Deliver to shp38@columbia.eduin one pdf file or to the Assistants’ station in Kravis 1120.

Under Business School standards, the project is Type A (with the group self-selected) in the table below:

Type	Designation	Discussion of concepts	Preparation of submission	Grade
A	group / group	Permitted with designated group	By the group	Same grade for   each member of the group
B	group / individual	Permitted	Individually   (No sharing of  any portion of   the submission)	Individual
C	individual / individual	None of any kind	Individually	Individual
D	(An optional category to be defined in detail by the individual faculty member)

CLASSROOM NORMS AND EXPECTATIONS

Classroom activities are to be conducted in an atmosphere of mutual respect, engagement, and participation, with the common goal of enhancing each other’s learning and mastery of the material. The professor wants to learn from you also! The 3Ps of the Core Culture apply:

Present:

•       On time and present for every session

•       Attendance is required, although not tracked

Prepared:

•   Complete pre-work required, expect cold calling

•    Bring name plates to class

Participating:

•    Constructive participation expected

•    No electronic devices unless for class-room purposes. Laptops permitted, but only if open to the course material

For each class, preparation involves:

(i)          Preparing the case(s) assigned for the class session

(ii)         Reading prescribed material

(iii)        Reading over the class notes for the session, to gain some familiarity in advance and to prompt questions you might raise in class