This article discusses the role of GAAP accounting from an investor's perspective. For all its flaws, a historical-based system of accounting is vital to the investment community, and I believe the moves toward fair value accounting should proceed with great caution. Framing the discussion in terms of valuation theory, I argue that investors are typically more interested in assessing the present value of residual income than the value of assets-in-place. I also provide examples of how historical accounting numbers can be (and are being) used by professional investors. A simple residual-income framework succinctly captures the essence of value investing. In fact, what academics have learned about fundamental investing in recent years dovetails nicely with the strategies used by legendary investors such as Ben Graham, Warren Buffett, and Joel Greenblatt.
