It's Easy Buying A Stake in a Public Company

Here's one of the better explanations I've recently read on the idea of fundamental analysis or "value" investing (from the Ideas Report:

Buying a stake in a publicly traded company is deceptively easy. Log into your brokerage account, type in the ticker of the company whose stock you wish to buy, and—voilà!—you own a stake in the enterprise. Many investors don’t even refer to companies by their name; they simply invoke the ticker symbol. The ease with which stocks are bought and sold obscures the underlying nature of a stock market transaction and invites bad decision-making. The trick is to avoid thinking of a stock as a readily disposable piece of paper and instead consider that you are buying a percentage of a business whenever you purchase a share of stock.

Read the whole thing here

Identifying Overvalued Equity

here's an interesting paper by Daniel Beneish of Indiana U. and Craig Nichols of Cornell titled "Identifying Overvalued Equity."

Here's the abstract:

Jensen (2005) argues that overvaluation changes the behavior of managers in ways that increase agency costs, but suggests that overvaluation is difficult to identify. We show that observable characteristics of changes in managers' accounting, operating, investing and financing decisions can be used to predict two likely consequences of overvalued equity: future stock price declines and overstatement of accounting earnings. In particular, we show that an overvaluation score (O-Score) that combines proxies for earnings overstatement, prior merger activity, excessive stock issuance, and the manipulation of real operating activities identifies firms with one-year-ahead abnormal price declines averaging -27%. We also estimate a model that integrates these various attributes to predict accounting restatements associated with fraud. In light of the costs associated with overvalued equity, the findings that firm characteristics can be used to identify overvalued equity should interest researchers who study overvaluation and professionals who oversee management on behalf of investors.

RTWT here.

It's an interesting paper, because it uses publicly available information to identify firms with high probabilities of negative returns. While it's probably not that applicable to individual investors, I can see their approach being of use to short-sellers (or those running long-short funds).

SEC Requests Accounting Data From Oil Firms

From the Wall Street Journal (online subscription required):

The Securities and Exchange Commission, fresh from scrutinizing how oil and natural-gas companies book their reserves, is requesting that oil companies divulge more in their accounting for exploratory drilling and other operations.

Finance majors often ask what they can do to make themselves more marketable. I almost always encourage them to take more accounting classes. For many of them, they'll start off in a position that requires them to use accounting data as inputs in some way (credit and collections, reporting, financial analysis, etc...). However, a typical curriculum only requires them to take one or two accounting courses. So, as end users, they often have little sense beyond the very basics as to the subtleties of how financial statements are constructed.