Recently, I mentioned that I would refer to a couple of significant books that you might want to read if you have not already. The title of my post today is actually the title of one of the books. It is written by Stephen Penman and published by Columbia Business School.

Penman says “Price is what you pay but value is what you get; the risk in investing is the risk of paying too much; anchor on what you know rather than on speculation; and beware of paying too much for speculative growth.” Upon reading words like this, you might guess (and you would be right) that I would surely “second the motion” of Penman’s words.

While working on my doctorate in accounting years ago, “efficient markets” was a theme woven through accounting and finance research. The notion that markets efficiently factor publicly available information into the stock price almost instantaneously was programmed into students. Further, we were taught that the stock market could efficiently price stocks, regardless of the accounting information presented and how it was disclosed (reflected on the face of the financial reports or disclosed in the footnotes). Some of it was quite “academic.”

Penman sets aside academic theory that is hard to apply to valuation and instead presents the usefulness of accounting to valuation and how, in a real sense, accounting and valuation are one and the same. His valuation presentation includes how accounting information relates to evaluating growth relative to helping an investor avoid overpaying for that growth.

After experiencing the real world of stock investing “hands-on” for many years, I find that while markets indeed react efficiently (timely) to new information, a “quick” reaction may prove to be an incorrect “knee-jerk” reaction when it comes to the true underlying value of an equity security. Accounting information cannot be separated from relevant valuation. I’m with Penman on this.

Have a great weekend.