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Learning value investing from scratch

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This is a roadmap for learning value investing that I wish I had when I started out. The value investing that I am referring to is value investing in the style of Graham and Dodd. This list of books allows a beginner to start from zero knowledge, and end with the necessary knowledge to conduct security analysis and valuation on their own. The books are listed in the recommended reading order, although it might be possible to skip around if you wish.

Financial analysis

This list of books aims to get you started as directly as possible towards the goal of independent security analysis. As a result, it does not contain many "easy" books, "light reading", history books, or general interest books. After completing the more technical books, you will always be able to read the less technical ones. However, the converse is not always true, so the focus here is on reaching serious technicalities as soon as possible.

Ideological books

These are introductions to the general philosophy and world-view of value investing. General philosophy will be the easiest part to learn, due to the minimal technical knowledge required. Minimal accounting knowledge is needed at this stage.

  • The Intelligent Investor by Benjamin Graham

    Try to get the latest editions, because the latest editions come with latest commentaries. The Intelligent Investor is an old book, so some things may have changed, and the commentaries will help in giving you information that is more relevant to today's world.

Accounting

You have to understand accounting and you have to understand the nuances of accounting. It's the language of business and it's an imperfect language, but unless you are willing to put in the effort to learn accounting — how to read and interpret financial statements — you really shouldn't select stocks yourself.

— Warren Buffett

Accounting is the language of business, and knowledge of accounting allows you to understand financial statements. An understanding of financial statements is crucial for finding and exploiting value. Although intermediate and advanced accounting is needed to truly understand financial statements, you should start with basic accounting so as not to be overwhelmed. Accounting knowledge allows you to understand more books, and allows you to understand the "real stuff". Here are some books for getting the big picture of accounting:

  • How to Read a Financial Report by John A. Tracy
  • Financial Statements by Thomas Ittelson

At this stage, you will be able to understand most value investing books. You could move on to intermediate accounting, although you can delay that until you are ready. Books for intermediate accounting:

  • Intermediate Accounting by Donald E. Kieso

    This textbook also has an IFRS (International Financial Reporting Standards) edition, so if you live in a jurisdiction that uses IFRS for accounting, or if you are primarily interested in IFRS, then get an IFRS edition. The non-IFRS editions deal with GAAP, which is the US accounting standard.

Accounting textbooks present financial reporting in an idealized light. It assumes that firms always want to present an accurate picture in their financial statements. However, this is not always the case. You must shift away from the mindset of "pretty accounting" if you want to read real financial statements. These books explain the hows and whys of financial statement distortion:

  • Financial Statement Analysis by Martin S. Fridson and Fernando Alvarez

    Most of the book deals with how real world financial reporting deviates from the pretty picture of most accounting textbooks. This will give you a taste of what it takes to read financial statements. The final part of the book is about valuation. Note that there are better and more detailed valuation books out there.

  • Financial Shenanigans by Howard Schilit and Jeremy Perler

Intermediate ideological books

You will need to know at least basic accounting to be able to read these.

  • Security Analysis by Benjamin Graham and David Dodd

    This is a value investing classic. The second edition (published in 1940) is often recommended for a first reading. Unlike The Intelligent Investor, this book does not come with commentaries, so readers are mostly on their own when it comes to judging the modern relevance of the contents. A part of the book deals with bond analysis, especially railroad and utility bonds. Although the reader may feel that the book is outdated, the book completely describes the methodology used in classic Graham and Dodd value investing.

Valuation

The exact methodologies outlined in Security Analysis by Graham and Dodd is too dated for direct application to today's environment, so we need to learn about valuation methodologies that can be applied in today's world. For that:

  • Financial Statement Analysis and Security Valuation by Stephen Penman

Conclusion

The books above will get you started by placing you at a level where you will be able to conduct your own analysis to exploit differences between price and value. However, the learning does not end even when you have finished these books. You need to read more and put knowledge into practice. You will need to keep your knowledge up to date, and constantly practise what you learn. Price and value will always move, so you will always have to be on the move too.