Time has a way...

To use the title of Aswath Damodaran's book on corporate valuation, investment decisions should be based on a combination of "Narrative and Numbers". In order to start developing an understanding of the numbers side, I recently took a super interesting Coursera course on financial accounting!

Near the start of the course I realized that non-cash items such as depreciation, amortization, and bad debt expense add artistic elements into accounting. Managers can legally get creative with accounting? What? My reaction exactly: the thought that the numbers published in an annual report present a twist on reality (and not reality itself) worries me.

But as I went through the course, I realized that this is partly because the future reality is unknowable till it happens. More importantly, I learned that provided the books are not cooked, time has a way of revealing and ironing out adventurous, aggressive accounting; if you don't account for non-cash items sufficiently, you will have to take write downs on assets in the future. (And similarly if you are too conservative, the expenses booked today will reduce future expenses.) Time just has a way...

So what did I take away? There are three things that were reinforced for me: 

• Time has a way of setting things right.
• One must carefully evaluate a long term track record. 
• You have to trust that the managers' interest is aligned with yours.