Any book that reaches its 4th edition (updated to 2011) should be good. That's true in spades for Financial Statement Analysis. Fridson and Alvarez have written a classic. It should be required reading and a constant reference source on the bookshelf of any investor intending to buy individual company stocks or bonds. It is a book for those who intend to follow Warren Buffett and increase the security of their investments not by diversification but by depth of knowledge and confidence in the companies whose securities they hold.
The book is not primarily an accounting text in the sense of indicating the mechanics or the theory of accounting. It assumes basic familiarity with balance sheets, income statements and cash flow statements. What the book does thoroughly and brilliantly is to explain how to analyze and interpret the numbers to enable an investor to figure out what is really going on in a company.
The authors take account of and put heavy emphasis on the motivations of company management for their own personal ends - everything from presenting results in the best light at the legal end to outright fraud at the illegal end. Through many simple examples they show where and how to look for signs of manipulation of accounts. They admit the limitations of even the most expert analysis. They note, explain and give examples of the necessity to be wary of auditors, regulators and boards of directors. Frank and severe commentary abounds but the book is not a diatribe and the reader is not left with a sour or negative view. It is entirely practical and realistic. The book moves the investor from the textbook into the real world.
Though not to the same depth, the book also explains how industry conditions need to be taken into account in interpreting financial ratios. It explains how factors like seasonality, cyclicality, capital intensiveness, size of company, maturity of the company or the industry all can impinge on the safety/danger of debt or equity and the relative over-/under-valuation of securities. Want to know the hows and whys of leveraged buyouts, mergers, serial acquirers, stock buybacks, reserves and write-offs? This book will tell you.
The viewpoint is that of an investor arming him or herself with defensive detective tools. Its motto could be the modification of the adage "trust but check" to "check, and keep checking".
One of the surprising, given the subject matter, and delightful features of this book is that it is highly readable and accessible. The writing style is engaging with enjoyable turns of phrase, the sentences are understandable and never confusing, the examples are simple enough but not too simple, the organization of topics within chapters flows naturally. The authors have mastered the art of providing just enough detail - sometimes only a little, sometimes a lot - to make their point.
- The walk through the dividend discount model is the most intuitive and insightful version I've come across.
- The five pages on Nortel weave together the methods (mostly abuse of accruals) and motivations (management bonuses) of the company's death spiral into a succinct morality tale.
- My strongest takeaway is a sense that the integrity of management is a critical element to judge since there are so many ways for manipulation to be done and it can be very difficult if not impossible to detect till it is too late.
- Page 232 reflects a small lapse in updating the new edition as the dates in a table do not match the text and the table on page 234 does match the text, though one can still understand what is going on. Perfection is hard to achieve!
- The reader can only gain understanding through this book. Being able to apply the knowledge would require a person to work through examples to fully absorb it as a practitioner. Presto! The authors have written a companion Workbook.