WWII 075: Learning Progression for the Accounting Mental Model, If I Buy Below Liquidation Value Will I Profit, How to React to Mutual Fund Mergers
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Main Topic: Learning Progression for the Accounting Mental Model
Charlie Munger has suggested we have to have a hundred models in our head as a latticework on which we can hang experience. In episode 55 I introduced you to the permutations and combinations mental model. In episode 63 I introduced you to the auto catalysis mental model.
I received a question from a listener through the AskJB function on the website about learning accounting, a critical knowledge to have if you are going to be an investor. Here is Alex’s question:
"I Have been realizing the importance of financial statement analysis and accounting when it comes to the valuation of a business. I have read a little about the history of accounting and took a financial accounting course in college but never really internalized how accounting works and how businesses may use accounting to misrepresent their true financial position.
I'm trying to find 10 books that are an absolute must read to better understand accounting, financial statement analysis, the role of a CFO and CEO on the development of the statements, and how they can be misrepresented. Would you recommend some books that every investor looking to become fluent in accounting without having to get a CPA?
Alex, thanks for this question and Congrats, you honed in on a very important mental model to master if you want to be a good investor. A working understanding of accounting is incredibly helpful in finding the skeletons in the closet of a public company.
Here are some suggestions for books that will help you develop the accounting mental model.
1. A good fundamental accounting textbook is "Financial Accounting" by Harrison/Horngren. Pretend you are taking a class, read it cover to cover and do all the practice examples and practice tests. This will get you 80% of the way to having a good working mental model.
2. Next, get a good financial statement analysis book. I read "Financial Statement Analysis - Theory, Application, and Interpretation" by Leopold A. Bernstein and John J. Wild. Do the same with this book, all the example questions, all the practice tests all the way through.
If you did 1 and 2, you are already in the top 5% of the class! Most will never even get through step 1. This is where discipline is handy: there is no substitute for hard work. The next few books really narrow in on the stuff management teams try to pull on us unsuspecting investors. Here are some suggestions from my library:
3. "Financial Shenanigans" by Howard M. Schilit.
4. "Quality of Earnings" by Thornton L. O'Glove.
6. "the Financials Numbers Game" by Charles Mulford and Eugene E. Comiskey
5. For extra credit, and to see the other side of this same coin, read "The Value Imperative" by James McTaggart. It will teach you how good management create value through the numbers.
Ask JB: Are you guaranteed a profit if you buy a company below liquidation value?
submitted 4 hours ago by RyBey
JB Says: No. There are no guarantees. Not all liquidations are alike. Benjamin Graham liked to invest in “net nets” where the company is selling below the value of its working capital and you are essentially getting all the physical assets for free. If you could take control of that company, you could liquidate it and make a nice profit overall. Unfortunately, you would often have to have control to make that happen as most management teams try to hold on to their jobs like a dog on a bone. The will wait until too late and end up in bankruptcy, and then still be holding on to their jobs like the dog again. That being said, if it’s still a viable company with potential and you are buying below liquidation value, you may be on to something
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