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Quality of Earnings:
A Synopsis, Part One

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By TMFJordan
September 23, 2004

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Overview
If you have been reading his Hidden Gems or other writings lately, you have been sure to see Tom G. mention the book Quality of Earnings by Thornton L. O'Glove.

Well, I finally decided to pick this book up and read it. After getting my copy from Amazon and spending a couple of workout sessions on the recumbent bike reading, I have come away extremely impressed with what he has to say to all of us.

While he is writing from a perspective grounded in the late-70s and early-80s, the fact is that his insights, if heard and heeded, would have save a lot of people a lot of money in the late-90s.

In this series of postings, I will try to condense done what I learned and put it out here. I am doing this, because I believe that what O'Glove says in his book is invaluable and should be "required reading" for anyone planning to purchase individual stocks.

General Comments
O'Glove, given that he is tackling a relative complex and dry subject, is an excellent and highly readable writer. He has an extremely wry and dry sense of humor, which sneaks up on you. On a number of occasions, I found myself laughing out loud, but only after I had time to digest what he said.

While you wouldn't expect it from a book with this title, Quality of Earnings is extremely approachable by readers with any level of investment experience. Given its highly approachable nature and value, I believe it should be on all investors required reading list.

The More Things Change...
As I read the first two chapters of Quality of Earnings, I came away with an even deeper sense of conviction of the truth in contained in George Santyana's statement: "Progress, far from consisting in change, depends on retentiveness. Those who cannot remember the past are condemned to repeat it".

If O'Glove's insights in Chapter 1, Don't Trust Your Analyst, and Chapter 2, And Don't Trust Your Auditor had been heeded by all of us during the Bubble Years, we would all be a lot.

In the chapter, Don't Trust Your Analyst O'Glove recites the laundry list of reasons to not trust one word that comes out of the mouths of stock analysts. The litany of conflicts of interest and pressure put on analysts to maintain "good ratings" won't be a surprise to those of us that followed the fallout of "The Bubble", but it will drive home the conviction that, as O'Glove states, the only expert on the market you can trust is you. His goal in this book, as is I believe Tom G.'s goal, is to help us become that expert. As he says, to use a clich�, he is seeking to teach us how to fish, rather than handing us fish.

O'Glove takes to task the talking heads we see on CNBC and Bloomberg, strongly critiquing them by saying that they are, using social critic Daniel Boorstein's definition of celebrity, famous for being famous. He lambastes most analysts as being too close to management with all of their knowledge of the companies they are following being spoon fed to them by the Investor Relations Department. He makes a strong cases that the individual investor can and will do a better job by getting the publicly available SEC filings (10Q and 10Ks) and pulling them apart on their own. It is interesting to put this comment in perspective by noting this was said prior to the advent of the Internet. Back then getting a 10Q or 10K was a much more difficult process. Today, it is a couple of mouse-clicks away via your web browser.

In the chapter And Don't Trust Your Auditor he speaks to the fundamental conflicts of interest, which weren't new to the Bubble Years, confronting auditors, making it impossible for us to trust their opinions. He points out the full range of these conflicts of interest. At the end, the only remedy he sees, is to not trust the auditor, but to get the source material yourself (those ever present 10Q and 10Ks) and dig through them yourself.

Getting Started
In the first two chapters of Quality of Earnings O'Glove hammers home, again and again, the simple message: Only you can be trusted! It is only you that can go through the data available and come up with a sense of the strength or weakness of a company.

I agree with this message in part, but I also see great value in what I have come to call "Open Stock Analysis", which forces me to reject the raw rugged individualism of O'Glove's message. Much like more can be achieved, with higher quality, in the "Open Source Development Model" with respect to software development, I believe that working collaboratively in an online community will help us to quickly identify the strongest companies (quickly implementing features) with the best value, while avoiding the portfolio killers (bugs).


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