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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

I wish to select stocks myself given the time that I am willing to put in. Obviously, to select stocks, one does not need to have the accounting knowledge of a Chartered Accountant. So how much is enough just to get started?

This question is inherently subjective. But I would like to obtain at least a small indication of where I should start exploring if I intend to learn to read the financial statements of publicly traded companies.

Flux
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3 Answers3

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Background:

I'm a senior majoring in accounting and management information systems.

Here is a question I answered a while back about financial statements and employee retention. In the answer that I provided at the bottom it was to assess a company's ability to pay by use of ratios. Likewise, similar accounting methods need to be understood and implemented when assessing stocks (which is where I believe Mr. Buffett was going with this).

Examples:

  1. How do COGS, across 3 different countries, affect foreign tax credits concerning administrative bonuses in reported SGA?
  2. Why would a company have a stock split of 1:3 when they had five years of consecutive losses of net income?
  3. What are the effects of LIFO and FIFO on net income?

As we can see the severity of the questions decreases, but if you cannot answer question 3 then you should study accounting principles.

So how much is enough just to get started?

You will never have enough knowledge to start, period. You will have to continuously be learning, so start sooner than later.

However you need neither economics or accounting knowledge if you were to learn technical analysis, many doubt the workings of this technique, but in my experience it is easier to learn and practise.

A comment on @Veronica's post.

Understanding economics and accounting are fundamental. Analysis, seeing trends, and copying are instinctual human traits that helped us evolve (we are very good at pattern recognition). Taking an intro economic and accounting course at a local community college is an excellent place to start when breaking the mold of pattern-thinking. You have to be critical in understanding what elements move a company's A/R in the statement of cash flows.

Where to start:

Read.

Literally, don't stop reading. Latest edition of Kieso's Intermediate Accounting? Read it. Cover to cover. Tax policies on Section 874, 222, 534? Read it.

This is your money, do not be lazy with it.

Take a class, read a book, ask questions!

Good Luck.

"Welcome to [the] Science [of Business], you're gonna like it here"

— Phil Plait
Flux
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Liam
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For analyzing most companies, with possibly the exception of financial institutions, not much. Of course you have to know the basics (how to read a balance sheet, statement of operations, cashflow statement, etc.) but these require no specialized in-depth knowledge.

Apologies to linking to an outside resource, but I think Aswath Damodaran does an amazing job in imparting the necessities of accounting for anyone interested in investing: https://www.youtube.com/watch?v=Jbp3-AU9v_g&list=PLUkh9m2BorqmKaLrNBjKtFDhpdFdi8f7C It should contain all the necessary basics to get you started. Feel free to have a look at further courses on valuation on his Youtube.

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From my experience you don't need knowledge of accounting to pick good stocks. The type of investing you are referring to is fundamental. This is finding out about the company. This website should help you start off: How to Choose A Stock: Fundamental Analysis

Investopedia will also be a useful website in techniques. A bit of knowledge in economics will be helpful in understanding how current affairs will affect a market, which will affect stock prices.

However you need neither economics nor accounting knowledge if you were to learn technical analysis. Many doubt the workings of this technique, but in my experience it is easier to learn and practise. For example, looking at charts from previous years it shows that during the last big recession, the dollar did well and commodities didn't. In this recession we are entering you can see the same thing happening.

Read about the different techniques before limiting yourself to just looking at financial statements. You may find a better technique suited to you, like these technical analysts: Top 7 Technical Analysts of All Time Share Their Secrets

Hope this helps.

Flux
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user51279
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