Sunday, October 9, 2011

Quality of Earnings: Chapter 2

Investors rely heavily on the financials that companies release. But managements have significant leeway when it comes to creating its results. In this book, Thornton O'Glove tells investors how to judge the quality of a company's earnings, in order to both protect against fraud and find value.

Carrying on the theme from the last chapter, O'Glove argues that you can't trust auditors, either. A number of situations are cited where auditors "erred". Companies went bankrupt only months after receiving clean bills of health from auditors.

O'Glove argues that this is not necessarily the result of incompetence. Again what is occurring is a conflict of interest. Auditors generate fees from their clients, and also seek to expand business with their clients in other ways. An adverse accounting opinion would not serve these interests well.

This re-inforces O'Glove's theme that investors must do the work themselves if they seek to generate a reliable opinion.

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