Extracting Gold that Investors Miss in the Financials
Investing Edge lies where others are not looking.
I’ve run a long/short equity hedge fund. I’ve also built and operated my own business. It took me years to realize something deeply contradictory about how I approached each of these roles.
As an investor, I lived by the idea that earnings, especially growth and surprise, were everything. Ball and Brown’s seminal 1968 paper showed that earnings announcements explained over half of all price-relevant information in a given period. That conclusion held up in retests as recently as 2019. Like most investors, I spent my days trying to predict the next earnings number. It was the north star.
But as a business owner? I barely looked at the income statement.
A Tale of Two Roles and Two Realities
Running my company, I cared more about the balance sheet. It told me whether we could survive, grow, or invest. The change in equity was how I measured our success. Decisions were made based on long-term value creation, available resources, and upcoming cashflow needs. Not quarterly net income.
It struck me then: Warren Buffett isn’t joking when he says he spends more time on balance sheets than income statements. And the old quip that EBITDA means “Earnings Before I Told Da Auditor”? That joke exists for a reason. Yet the investing world still chases the income statement with tunnel vision.
The Realization: These Aren’t Opposites
We often treat investors and business operators as living in different worlds. But they shouldn’t be. In fact, understanding how business owners think can give public-market investors a powerful edge.
Markets are fast-moving. We do need to pay attention to high-frequency signals like earnings beats or guidance revisions. But we also need to keep an eye on what really drives long-term business value. That is, the parts of the financials that don't always move the stock today but matter immensely tomorrow.
As a mentor once told me: “Don’t just focus on what’s counted. Focus on what counts.”
Just because earnings are easy to track doesn’t mean they’re the whole story. If anything, that’s the trap.
The Lost Language of the Balance Sheet
Over the years, I’ve interviewed more than a hundred analyst candidates for hedge fund roles. In stock based case study tests, not a single one mentioned the balance sheet. Ever. It’s a forgotten language. But that’s also what makes it a source of true edge. If most investors ignore it, you have a better chance of finding something they’ve missed.
That’s why forensic accounting - really digging into how the income statement, balance sheet, and cash flow statement link - can reveal a lot more about a business’s prospects and health than chasing headline EPS alone.
AI Can Help Us See What Others Miss
The best part? We now have tools that can do this work faster and more consistently than ever. Large language models like GPT, trained on accounting standards, textbooks, and decades of financial filings, can automate the forensic accounting process. With the right prompts, grounded in the work of leading thinkers, you can scan a company’s financials in minutes for signs of:
unsustainable accruals,
mismatched cash flows and low quality earnings,
shifting revenue recognition policies
unusual working capital shifts,
or hidden leverage.
What once took hours or got skipped altogether when earnings season got busy, can now be run in parallel, reliably and scalably.
Codifying the Greats
These aren’t just black-box AI tricks. They’re based on the core principles of:
Graham & Dodd’s Security Analysis (quality of earnings, margin of safety)
Stephen Penman’s Financial Statement Analysis (clean surplus accounting, residual income logic)
McKinsey’s Valuation (ROIC > growth, cash flow trumps accounting income)
White, Sondhi & Fried’s Analysis and Use of Financial Statements (statement linkage and interpretation)
Schilit & Perler’s Financial Shenanigans (pattern recognition for red flags)
With the right prompt structure, these principles can be rigorously applied for you, across filings and companies, in seconds.
Don’t Wait for the Next Blow-Up
If you're not already using forensic accounting techniques or leveraging AI to do it you’re simply waiting to be caught off guard. Eventually, there’ll be a surprise write-down. A short-seller report. A downgrade that wipes out a year’s worth of gains. But these moments rarely come without breadcrumbs in the financials.
You just need to be looking.
The Takeaway
The business owner in me urges every investor: open the other eye. Stop looking at just the income statement. The real gold lies scattered across the entire financial footprint of the company. Balance sheets aren’t boring. They’re predictive. And now with the help of AI you can mine them at scale.
And if you want to know more about The Inferential Investor - it’s all laid out here.