Stephen H. Penman, Financial statement analysis and security valuation (3rd ed), McGraw-Hill/Irwin, International edition (2007) xxix + 776 pages, £44.99, ISBN10: 007-125432-3 PDF

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450 Book reviews decisions. This analysis extends to consideration of socially-responsible investment strategies and investments and their drivers and profitability. The author reports upon the increasingly sophisticated engagement and dialogue that is emerging between institutional investors and th...

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450

Book reviews

decisions. This analysis extends to consideration of socially-responsible investment strategies and investments and their drivers and profitability. The author reports upon the increasingly sophisticated engagement and dialogue that is emerging between institutional investors and their investee companies in the area of social and environmental information as part of socially-responsible investment. The author offers the view that such issues are now being integrated into the heart of corporate-governance concerns for the institutionalinvestment community. The chapter concludes with the statement that “this represents a deep change in the attitude of business and financial institutions towards social responsibility, endorsing a broader remit than that encapsulated by pure agency theory” and that a “broader agenda for corporate governance, which embraces a stakeholder theory approach, may no longer be viewed as inconsistent with value creation in the long run” (p. 302). Part III concludes with chapter 11 which provides a brief insight into the author's view of the future direction of corporate governance and accountability, which touches upon investor activism, the global convergence in corporate governance, and corporate-governance reform. In conclusion, it is fair to say that the author achieves the stated aims of this work in an informative and easily-read format. The book not only provides a great deal of explanation and detail on the topic of corporate governance and accountability for undergraduates and practitioners alike, but also provides a very useful discourse on a range of associated theories, with reference to key literature on corporate governance and accountability, for postgraduates embarking on their research. References Cadbury, A. (1992). Report of the committee on the financial aspects of corporate governance (Cadbury report). Higgs (2003). Review of the role and effectiveness of non-executive directors (Higgs report). London: Department of Trade and Industry. Tyson (2003). Report on the recruitment and development of non-executive directors (Tyson report). London Business School.

Jonathan Edwards Business School, Bournemouth University, United Kingdom

doi:10.1016/j.intacc.2007.09.001

Financial statement analysis and security valuation, Stephen H. Penman, 3rd ed. McGraw-Hill/Irwin, International edition (2007), xxix + 776 pages, £44.99, ISBN10: 007-125432-3 Penman's book is a well crafted volume, which offers plenty of content including detailed material on “hands-on” financial statement analysis and valuation. It is comprehensive and such, the 2nd edition was widely adopted. The book provides a helpful reference for students in economics and business, particularly for MBA candidates. Penman's book also serves the needs of professionals who are confronted with valuation

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tasks in everyday life. The book is intended primarily as a book about doing. Hence, it takes a pragmatic viewpoint and is suited as a standard textbook for courses that aim at a preparation for practical valuation tasks. The 3rd edition has kept this intention as well as the basic structure of the 2nd edition. While the book has gained somewhat in length, the overall outline of the topics has kept its clarity. Penman's 3rd edition is structured along five main parts with two introductory chapters. These cover the basics of statement analysis and valuation (Part I, Chapters 3 to 6), statement analysis with a focus on value generation (Part II, Chapters 7 to 12), methods of forecasting corporate payoffs (Part III, Chapters 13 to 15), quality aspects in accounting (Part IV, Chapters 16 and 17) and finally risk considerations (Part V, Chapters 18 and 19). While Parts II to V can be considered as electives, Part I forms the mandatory core part of the book. It contains an introductory guide in the analysis of financial statements from the U.S. perspective and provides a summary of financial market history, which includes results on long run average returns on important asset classes. Part I then continues with a discussion of accrual accounting and the application of important alternative valuation models. These models include the method of multiples, dividend discounting, cash flow discounting and the residual earnings model. There are several introductory treatments of financial statement analysis and valuation. The classic corporate finance textbook by Brealey, Myers, and Allen (2005), for example, offers a compact introduction to security valuation in its 4th chapter. That chapter may well serve for a bachelor's level course but also for an introductory master's level course (especially when the program is not focused on fundamental valuation issues). More comprehensive treatments of the subject within a full one-semester course surely ask for more intense textbook treatments. One example to note is the textbook by Soffer and Soffer (2003). The latter authors offer a book, which is relatively compact while it covers contents in an elegant and consistent manner. A clear advantage of Penman's textbook is its comprehensiveness and its richness in interesting practical examples. Most of them are compact case studies drawn from recent real-world problems. This feature offers a great amount of exercises and allows lecturers to choose their collection of favorite examples for in-class discussion. Moreover, it offers plenty of training opportunities to students. Making lecturing with the textbook an even more rewarding task, Penman has updated and extended his set of “real-world” examples in the 3rd edition. In this sense, the book offers a unique view of financial analysis. Financial statement analysis surely has many limitations. At least some of them should be noted on a textbook level. Also, putting a critical eye on valuation results is an important skill. Penman does address these issues in the book. On page 8, for example, Penman refers to the 1990s stock market bubble and points out examples of speculative financial analysis. As an example, he gives a critical assessment of a valuation of America Online Inc. as done in 1999. The 2007 valuation perspective is clearly other than the one in 1999, but Penman shows with his examples how to develop sound and critical valuation skills. And with all that sound fundamental analysis, Penman does not neglect the psychological aspect of price assessments during a potential period of exaggerated valuations: “In a bubble, investors behave as if they are joining a chain letter. They adopt speculative beliefs that are then fed on to other people” (p. 7). This critical perspective on valuation is kept throughout the book. Another example is the case of MCI WorldCom on page 49, which points out to the (now

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better known) limits of financial statement analysis, which arise from potential balance sheet manipulation. The book offers an intense discussion of accruals, which are known to be particularly critical in valuation (see Part I). Chapter 17 is on statement quality and includes special sections such as “Sensitive areas that are prone to manipulation” (Table 17.2, p. 643) and “Situations where manipulation is more likely” (Table 17.3, p. 644). Considering the textbook for a class, which is taken in part by students in a finance program, I have made the experience that it is advisable to use Penman's volume for a course at an early stage where it will be more appropriate. Finance students at later stages sometimes get confused with several terms and concepts, which they were taught in finance classes as concepts are sometimes understood and used quite differently within Penman's text. Examples are statements like “avoid trading at the wrong price” (p. 4), which may–at least to some–indicate the operational risk of a mis-trade, while what is meant is of course “avoid trading at the given market price when it deviates from a given subjective fundamental value assessment”. Also the question for an arbitrage opportunity due to the potential mis-valuation of a single corporation (case on page 107) sounds a little odd to those who understand the no-arbitrage concept in the sense of financial economics. Here, it would be better to point out to portfolios of mis-valued assets and then use the notion of (statistical) no-arbitrage in the sense of the Arbitrage Pricing Theory (APT). Also, empirical evidence, such as the book-to-market anomaly, could be cited and would provide a sound justification for the “activist approach” as taken in the book (p. 3–6). This would strengthen the book's obvious perspective that real-world capital markets are inefficient. However, it remains unclear in the book what the overall investment strategy in buying single fundamentally undervalued stocks would be and what its prospective performance could be. To my knowledge, there is little evidence that fundamental analysis has led to consistent superior performance except for a few exceptional investors. The appropriate argumentation that–while obtaining ultimate diversification at low cost–“the index investor is in danger of paying too much” (p. 5) would rather point out that diversified strategies may work as a perfect synthesis of the advantages of indexing together with those from sound fundamental analysis. From the teaching perspective, it is a standard question how many different textbooks should be used to accompany a course. Penman's textbook is surely very well suited to be considered as a sole textbook source due to its richness as indicated above. Still, students sometimes feel that the text is relatively long–not only overall, but also when referring to a single subject matter–and hence ask for a more condensed outline of the subject. The summary of formulas in the appendix at the end of the book as well as each “Analysts Toolkit” at the end of each chapter both clearly help to focus on the major issues. Still, some readers may have the impression that fundamental principles, which are relatively few and non-technical, as well as their interaction appear less obvious due to the immense amount of other information, sometimes repetitions or other verbal discussion in the book. This matter seems to be due to a fundamental, potentially hard to manage, trade-off between comprehensive and focused coverage of contents. Penman's great job with the book is that–in many regards–it integrates finance theory with accounting concepts. The obvious aim of his concept is to efficiently use disclosed information for valuation purposes. Seen from the finance perspective, some readers may ask for a textbook with more content on valuation models and their critical assessment.

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Asset pricing models are briefly noted on page 98 yielding the impression that there is only “beta bashing” according to the CAPM and nothing else in the literature. The appendix to Chapter 3 points out the APT and the Fama–French three-factor model. While any of these asset pricing models is admittedly unreliable (leaving room for discussion about the appropriate required rate of return as it is stated in the text, see p. 115–116), any unreliable estimate of the rate of return will have a substantial impact on the reliability of the valuation results as derived in the book (Chapter 18 on risk analysis hardly addresses this issue as it is a summary on standard risk management tools in finance). Also, it is exactly models such as the one by Fama and French, which would be the ones to close the gap between finance and accounting. It would be helpful to find a related discussion in the text. In summary, a more integrated treatment could contain more theory and empirical findings in terms of asset pricing models and the cost of capital, thereby focusing on ways of practical model implementation. Given results on model performance, this could finally be combined with the cutting-edge valuation applications of the present textbook. To my knowledge, there is no book to fill this gap to date. However, it could be a future line along which the book (or a new issue) could be developed. References Brealey, R. A., Myers, S. C., & Allen, F. (2005). Principles of corporate finance (8th ed.). McGraw-Hill/Irwin. Soffer, L. C., & Soffer, R. J. (2003). Financial statement analysis: A valuation approach. Pearson/Prentice Hall.

Niklas Wagner Faculty of Economics and Management, Leibniz University, Hannover, Germany

doi:10.1016/j.intacc.2007.09.003...