Somewhere around the 1980s, people got the notion that lifelong learning was a trend. Adult education classes, which had been around for a hundred years, suddenly bloomed beyond GED tutoring, typing and prenatal parenting classes. Community colleges began to sprout non-traditional student bodies that outnumbered traditional full-time day students by three to one.

We’ve all met people who are constantly getting excited about new things, turning rocks, poking into interesting ideas. And we’ve all met people who haven’t updated an opinion, taken a class in anything, or advanced more than absolutely necessary to operate their televisions since they graduated from high school.

The learners are the fun people. I wouldn’t waste a minute of my precious life hanging out with the second sort. Fortunately, lifelong learning is almost gospel now and there are a lot more people staying fresh than going stale. These days, adult learning is serious business. Schools like University of Phoenix have grown huge on the trend. But some learning is still self-directed and privately gained.

I’m all for both types. Much of what I write here and in Rising Tide Letter is for private learning. Informal, relatively pain-free I hope, but I also hope it is immediately useful to you. But as a person who has returned to the classroom at least once in every decade, I like the formal route, too. Well, I should. That’s how Andy and I met, as the two oldest students on the student newspaper staff, surrounded by exciting and invigorating “peers” who happened to be 10 or 15 years younger. The last time I returned to school was this past spring, where one of the students was 40 years younger than I —hey, he was a prodigy, OK?

This is why I loved the letter from Bernadette:

Dear Lynn:

I am a subscriber to the Rising Tide Newsletter and have enjoyed the quality of your research.

I particularly enjoyed your series of articles on trend lines and volatility.
They motivated me to look into chart analysis a little deeper.  I am
presently studying John Murphy’s book “Technical Analysis of the
Financial Markets”. 

There is however one additional field in which I would like to further my education: the reading and interpreting of financial statements from an investor’s point of view.  I was hoping that you could recommend a book that covers this subject.

Not only do I applaud your drive, Bernadette, but it turns out I do have some suggestions.

First of all, learning to read, say, a balance sheet or income statement is not in itself horribly difficult. On one side you have assets, on the other liabilities. Assets increase proprietorship…

But the trick is really in understanding the nature and quality of the entries. Often, there’s more useful information in the footnotes, than in the financial statements themselves. While a quick scan can definitely show whether debt is too high or capital expenditures are too low, we can get that information summarized in a “key statistics” page right on our computer. But the numbers don’t tell all. Is that revenue from sales booked when an order comes in, when product is shipped, or after the bill is paid? Is it final, or should there be a reserve for returns? Is the increase in inventory an effect of stockpiling commodities in front of rising prices (probably a smart move), or did last season’s poor sales cause it? Or, is it the side effect of a change in the inventory system.

To address questions like that, there’s one book I’ve found to be a great introduction and a good read. It’s not new, and certainly not exhaustive, and some examples may seem a little dusty. But it’s a terrific way to enter the topic and benefit from the insights of someone who knows this game very well. The book is Quality of Earnings: The Investor’s Guide to How Much Money a Company Is Really Making by Thornton L. O’Glove. It’s a classic. One of the great chapters is an early one on what to expect from the Shareholders Letter in the financial reports.

My second suggestion to anyone who’s never done it or who has done it and forgotten everything is: take Accounting 101. Hurry, it’s September, you might be able to walk into a class right now. You don’t have to go to Wharton or Stanford Business to get a good foundation. There is probably a perfectly sufficient class at a community college near you. The only thing I do suggest is that you take it for a grade—none of this “audit” only stuff. Put yourself on the line and you’ll take it more seriously.

A lot of us mature investors did not have accounting in our background and it seems much more mysterious than it should. I don’t exactly remember why I took it. It certainly was not required for my English Linguistics major (or the majors in French and Zoology that I tried out first). But along with a 9-credit class in Systems Analysis, this is one course I am eternally glad I did take. It has proved far more useful than I ever imagined.

A final note here, though. A quick read of a few cases prosecuted by the SEC will tell you that even with due diligence, you can’t uncover a determined crook by looking at numbers—not early in the game, anyway. Some cases the SEC is pursuing in courts now concern companies that invented practically everything in their financial statements. They never even had the offices, assets or the cash flows they claimed.

Fortunately, such total frauds are comparatively rare and typically limited to very small way-off-Wall Street startups in bulletin board stocks. Most of the time, we are simply trying to separate the good ideas from the not-so-good ideas. Simply knowing basic accounting and paying attention to the business’s plans and progress will take you a long way in doing that. I certainly believe you are better off making an effort to find out what you think for yourself than blindly trusting what analysts who are paid by investment banks say.

Good luck, and do buy that book!

Lynn

Source: Learning the Language of Financial Statements