Equity Edge


The book is an effort to compile finance and accounting under a sole rubric. Stephen Penman has clings to the basic finance theory principles. But it provides a refined and ameliorated version of the principles from a fundamental perspective.


Penman is a professor at the Graduate School of Business, Columbia University. In the Year 1991 he was awarded with Notable Contribution to Accounting Literature. His previous book the Financial Statement Analysis and Security Valuation is now being published in its 5th edition. For which he received an award of the Deloitte and Touché Wildman Medal in 2002. Stephen Penman has his expertise in Investment Strategy and Value Investing. So the book is a demonstration of his approach towards it.

Further, the writing will be like reading a plumbing manual to multiple readers but will be a valuation bible for investors. It will be difficult for beginners and amateurs to understand the content in one read. As the book progresses the explanation of concepts are exhaustively. The book focuses on the chief aspects in fundamental financial principles which have faded in the background over the years. Maintaining equilibrium of finance and accounting the content is explicit. It offers fresh view on the accounting principles. The author expresses his doubts on the level of reliability that we have on accounting. According to him the opinions/advice provided to the shareholders/investors must be on the basis of facts and figures of business. It must not be on mere speculation.

“Value is about business, not about paper.”- Stephen Penman.

It covers an array of the elementary financial and valuation concepts that are practiced on a day-to-day basis. Stephen recommends its readers to return to the basics making it the cynosure of his book. The first chapter mentions the diversion that exists today. It explains that where the focal point is not the business but the tools and devices that focus on paper. Stephen scraped the theories which were earlier dependent on published financials. He says that we must abandon the finance theory models which do not provide useful tools. It must be substituted with models that are the roots of accounting.

Furthermore it has 10 principles in the initial chapter on the basis of fundamentalist valuation. It underlines the distinction between the valuations based on rudimentary principles. Further it also bases the valuations formulated on finance methods and actual accounting rules. Stephen plays on the front foot with the underlying support of his business knowledge.

Moreover, Stephens approach towards the financial fundamental is ambiguous. He has an inclination to accept some of the financial principles with an open mind. Whereas some of the principles he ruthlessly scratches it out. There is an explanation behind these principles in the latter chapters of the book. 

After exposing the reader to the entire criticism author concentrates on what should a fundamentalist base his valuations. ‘The Accounting Approach’ is not an out of the way answer. Moreover it is according to Penman the accounting approach is not the traditional accounting methods adopted. He presses on the fact that as a fundamentalist an individual should possess caliber of distinguishing right and wrong accounting.


The financial economics theory is established by Modigliani and Millers papers from 1958-63. The no-arbitrage principle and the Efficient Market Hypothesis are used as criterion to individualize fundamentalist analysis and fundamentalist approach. According to the Penman you don’t buy a stock, you buy business. The focus here is that finance approach is on the basis of the valuation of the stock. On the other hand, the fundamentalist approach is on the basis of valuation of the business. 

But he is not completely negative towards the fundamentalist approach. Although some of the finance ideas should be thrown away but others are acceptable. This is where the author seems rhetorical in his writing. He introduces some of the basic principles of financial economics only to scratch them. Later he re-formulates them in an advanced manner and manifests them to be acceptable.

The book lays strong emphasis on the calculations of the valuation. So as a reader you want to understand the calculations of the company’s valuation this book is not strongly recommend. The book primarily focuses on distinguishing the concepts of Fundamentalist approach and Fundamentalist accounting. The second broadly covered topic is the concept of mis-pricing. For instance for calculating the actual growth of a company first calculate the value of the company. Calculations must be on the assumption that there is no record of the growth. It is in comparison to the information along with the current growth level of the company.

In certain sections the author justifies accounting based valuation. With reference to his example in chapter 8 he suggests that the market price should be challenged. This becomes the reference point for validating the valuation achieved through accounting procedures. This is a loophole since there is no alternate mechanism provided in the book for calculation.


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