20688 - ACCOUNTING FOR VALUE
Course taught in English
Go to class group/s: 31
Class-group lessons delivered on campus
To feel comfortable in this course, you should be familiar with basic Financial Accounting topics (the background to financial statements) and basic Finance topics relevant to investment decisions and corporate financial policy (e.g., portfolio diversification, cost of capital, DCF methods). Courses could have been studied at graduate or undergraduate Level.
Value investors use valuation multiples or estimate the intrinsic values to identify cheap or expensive stocks. Financial statement information is central to value investing. But we should use financial statements intelligently. We need to understand how to infer value from such accounting numbers, e.g., earnings, book value, cash flows, return on equity, and return on assets. We need to understand the pitfalls mechanistic application of textbook models – there are traps to be avoided if we are not careful. We need to be confident in the inferences we make about the economics of businesses and the implications for valuation. While “profitability” is important in valuation, the way accounting works can distort and bias measures of profitability, obscuring “real” profitability. How can we deal with accounting measurement attributes and ways in which they might differ across companies with different business models, or companies in different industries and countries. In this course we exploit knowledge of how accounting “works” to CHALLENGE market prices. This requires us to appreciate some quite deep issues relating to “financial reporting quality.” However, while we make allowance and adjustments for aspects of accounting that obscure the economic reality, our main focus is on the issue of appreciating the value implications of accounting numbers to develop a systematic value investing methodology that avoids naive reliance on valuation multiples.
Accounting numbers, when understood and used intelligently, can help the value investor understand businesses and the value in those businesses. However, accounting can easily be misused and investors can fall into the Value Trap. We learn to understand the Value Trap and how to avoid it. The key is to develop a systematic approach to value investing using accounting numbers to understand value and to challenge the market price if it is different from estimated value. Challenging the market price helps avoid the greatest risk in investing, the RISK OF PAYING TOO MUCH!
The main topics we consider are as follows:
- Principles of value investing.
- The Value Trap and How to Avoid It.
- Accounting for the Market Price.
- Accounting for Leverage and Financing Risk.
- Accounting for the Profitability of the Business.
- Accounting for Growth.
- Accounting for Growth and Risk.
- Accounting for Value in the Balance Sheet.
- Accounting for Value in the Income Statement.
- Accounting for Value in Special Situations.
- Understand the challenges and information needs of traditional and quantitative value investors.
- Explain the role of fundamental finance and accounting principles in accounting-based valuation of the firm and in challenging market prices.
- Explain how accounting-based valuation models can be obtained from the dividend discount model.
- Understand the advantages of accounting-based valuation relative to discounted cash flow models.
- Discuss the relevance of measures of accounting value and profitability in valuation.
- Explain the effects of financial leverage and operating leverage in valuation.
- Explain the connections between growth and risk in accounting-based valuation.
- Understand the importance of separating financing and operating activities in valuation of the firm.
- Discuss concepts of accounting quality in the context of the balance sheet and income statement.
- Explain how speculation in future growth can be an important element in market prices of firms’ securities.
Estimate the intrinsic value of firms based on reported and projected financial statement information.
Demonstrate how valuation multiples, profitability and leverage measures articulate.
Critically analyze the growth expectations implied by market prices with reference to knowledge of the business and the drivers of value, growth and risk.
Reformulate financial statements to separate financing and operating activities and to eliminate GAAP procedures that may obscure business fundamentals.
Work with published financial statements to assess the quality of financial statement information for valuation to inform investment decisions.
Apply financial statement analysis methods and diagnostics to assess potential sources of growth and risk, including accounting risk.
Develop a comprehensive case study report for value investors based on financial statements and broader financial narratives from regulatory filings and annual reports.
Apply the theoretical framework developed in the course to evaluate special situations including mergers and acquisitions and corporate restructuring.
Use the theoretical framework developed in the course to evaluate accounting-based stock market anomalies that suggest the predictability of stock market returns.
Work cooperatively in small groups to discuss case study materials, figure out case solution methods and highlight questions to be discussed in class.
Work successfully in a small group, cooperating with team members on diverse tasks necessary to produce and present a team report.
- Face-to-face lectures
- Online lectures
- Exercises (exercises, database, software etc.)
- Case studies /Incidents (traditional, online)
- Group assignments
- Interactive class activities (role playing, business game, simulation, online forum, instant polls)
The learning experience of this course is based on:
- Face to face: lecture sessions are interactive and will include discussion of principles and methods, and then case studies. We will use real-life case studies of companies we all recognize. Cases have been updated with the most recent data available. We will discuss cases, and work through solutions during lecture sessions. The goal is to emphasize the challenges of real world accounting-based value investing.
- Incidents: papers, press news and practical mini cases are provided and discussed in class.
- Project: a group assignment that uses knowledge of the tools and techniques of accounting-based valuation and real life data, reports about a company and analysts' forecasts to test the market price. You will develop your thinking on the group case continuously through the course as we study different topics. Final case reports will be presented to the class.
Attending students are assessed based on:
- Group project: 45% of the final grade. Contributions to class discussions based on group cases, written project report and group presentation. The project is designed to test the ability of students to apply theoretical knowledge of accounting-based valuation methodologies to test the current market prices of one or more real companies using firms’ real world published financial statement information and other financial disclosures; to demonstrate understanding of the ability and limitations of financial statements to reveal information about business economics; and to assess the growth prospects and risks associated with investing in specific companies and their implications for the value investor using financial statement analysis methods.
- Final exam: 55% of the final grade. The final exam aims at testing students understanding of the theoretical relationships between intrinsic value, measures of accounting value and profitability, leverage, growth and risk; and to apply this knowledge in calculations based on simplified examples abstracting from real world detail.
Non- Attending students are assessed based on:
An individual case project report: 45% of the final grade. The project is designed to test the ability of students to apply theoretical knowledge of accounting-based valuation
methodologies to test the current market prices of one or more real companies using firms’ real world published financial statement information and other financial disclosures; to demonstrate understanding of the ability and limitations of financial statements to reveal information about business economics; and to assess the growth prospects and risks associated with investing in specific companies and their implications for the value investor using financial statement analysis methods.
- Written exam: 55% of the final grade. Aimed at testing students' understanding of the theoretical relationships between intrinsic value, measures of accounting value and profitability, leverage, growth and risk; and to apply this knowledge in calculations based on simplified examples abstracting from real world detail.
The course material is exclusively represented by:
- S. PENMAN, Accounting for Value, Columbia Business School Press.
- Slides - provided through Bboard.
- Readings - provided through Bboard and in S. PENMAN, Financial Statement Analysis and Security Valuation, Irwin/McGraw-Hill, 2013, 5th ed.
The course materials (e.g., hands outs and teaching notes) are regularly downloadable from Bboard platform. Teachers make the materials available throughout the course.