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Preface vii

analyst’s earnings forecast converted into a valuation? How can an investor rely on earnings
when earnings are sometimes measured with doubtful accounting methods? What role does
the balance sheet play? What is a growth company and how is growth valued? What does a
firm’s price-earnings (P/E) ratio tell you? What does its price-to-book ratio tell you? How
does one determine what the P/E or price-to-book should be?
Most important, the framework gives you the security that your analysis is a sound one.
The framework is built block by block from “first principles” so that you see clearly where
the analysis comes from and, by the end of the book, have a firm understanding of the
principles of fundamental analysis. You will also be able to distinguish good analysis from
poor analysis.

Practical Tools
This book is about understanding, but it is primarily about doing. Concepts and
frameworks are important only if they lead to analysis tools. Each chapter of the book ends
with a list of Key Concepts, but also with the Analyst’s Toolkit that summarizes the key
analysis tools in the chapter. By the end of the book, you will have a complete set of tools
for practical analysis. The Toolkit is efficiently organized so that the analyst proceeds in
a disciplined way with the assurance that his or her analysis is coherent and does not
overlook any aspect of the value generation in a firm. The book identifies too-simple
methods of analysis and shuns ad hoc methods. However, it also strives to develop simple
schemes, with a sense of trade-off between the benefit of more complicated analysis over
the cost. At all points in the book, methods are illustrated with applications to firms such as
Google, Cisco Systems, Nike, Microsoft, Coca-Cola, and many more.
Most of the analysis and valuation material in the book can be built into a spreadsheet.
So, as the book develops, you are given directions for building and embellishing a
spreadsheet program, with further instructions on the book’s Web site. By the end of the
book, you will have a comprehensive analysis and valuation product that you can apply to
almost any firm and use for active investing. A comprehensive guide to building
spreadsheets—Build Your Own Analysis Product (BYOAP)—is on the book’s Web site.
Off-the-shelf spreadsheet products are available (many with faults), but you will find it
much more satisfying to build your own, and certainly you will learn more this way.

Valuation and Strategy

The tools in the book are those that a security analyst outside the firm uses to advise clients
about investing in the firm. These analysts present their recommendations in an equity
research report. After studying this text, you will have the ability to write a persuasive,
state-of-the-art equity research report. But the tools are also those that a manager within a
firm uses to evaluate investments. The analyst outside the firm values the firm on the basis
of what he or she understands the firm’s strategy to be, while the manager within the firm
uses the same tools to evaluate investments and choose the strategy. The techniques that are
used to assess the value of a firm’s strategy are also the techniques used to choose among
strategies, so this book integrates valuation analysis and strategy analysis.

Accounting-Based Approach to Valuation

Valuation texts typically use discounted cash flow analysis to value businesses. However,
analysts typically forecast earnings to indicate business value, and equity research reports
primarily discuss firms’ earnings, not their cash flows, to get a sense of whether the firm is
making money for investors. “Buy earnings” is indeed the mantra of investing. The stock
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viii Preface

market focuses on earnings; analysts’ and managements’ earnings forecasts drive share
prices, and when a firm announces earnings that are different from analysts’ earnings
estimates, the stock price responds accordingly. Revelations of overstated earnings result in
large drops in stock prices—as with the Xerox, Enron, Qwest, WorldCom, Krispy Kreme, and
other accounting scandals that broke as the stock market bubble burst. Investment houses are
increasingly moving from cash flow valuation models to earnings-based valuation models.
This book focuses on earnings forecasting and the methods for converting earnings
forecasts to a valuation. The reason will become clear as you proceed through the book:
Earnings, appropriately measured, give a better indication of the value generation in
a business, so the analysis of earnings prospects leads to a firmer understanding of
fundamental value. Graham and Dodd and the fundamental analysts of earlier generations
emphasized “earnings power.” This book maintains that focus, but in a way that is
consistent with the principles of modern finance. One must be careful, for there is a danger
in paying too much for earnings.

The Quality of the Accounting

With an understanding of how accounting should work, you will develop an appreciation in
this book of what is good accounting and what is poor accounting. By the end of the book
you will recognize the defects in financial statements that are issued by firms and will have
developed a critique of the “generally accepted accounting principles” and disclosure rules
that determine what is in the statements. You will also understand how the accounting in
reports can be distorted, as well as discover tools that detect the distortion and give you an
indication of the quality of the accounting that a firm uses.

Integrating Finance and Accounting

Financial statements are prepared according to the dictates of accounting principles, and
you take accounting courses to learn these accounting principles. Your appreciation of
financial statements from these courses is often in terms of the accounting used to prepare
them, not in terms of what the financial statements say about investing in businesses.
Principles of finance guide investment analysis and you typically take finance courses to
learn these principles. However, the investment analysis in these courses often does not
employ financial statements or accounting concepts in any systematic way. Often you see
finance and accounting as distinct or, if you see them as related, the relationship is vague in
your mind. Finance courses are sometimes dismissive of accounting, while accounting
courses sometimes propose analysis that violates the principles of finance. This book
integrates your learning from finance and accounting courses. By integrating financial
statement analysis and fundamental analysis, the book combines accounting concepts with
finance concepts. Accounting is viewed as a matter of accounting for value and the
accounting for value is appropriated for investment analysis. The organized structure of the
financial statements helps organize fundamental analysis. Accounting principles for
measuring balance sheets and income statements are incorporated as principles for
measuring value. All analysis is performed in a way that is consistent with the principles of
modern finance and with an appreciation of what is good accounting and what is poor
accounting.

Activist Approach
Investment texts often take the view that capital markets are “efficient,” such that market
prices always reflect the underlying value of the securities traded. These texts are primarily
concerned with measuring risk, not with valuation. The investor is viewed as relatively
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Preface ix

passive, accepting prices as fair value, concerned primarily with managing risk through
asset allocation. This text takes an activist’s perspective. Active investors do not “assume
that the market is efficient.” Rather, active investors challenge the market price with sound
analysis, checking whether that price is a fair price. Indeed, they exploit what is perceived
to be mispricing in the market to earn superior returns. Active investors adopt the creed of
fundamental analysts: Price is what you pay, value is what you get. They believe that an
important risk in equity investing is the risk of paying too much for a share, so active
investors seek to gain an appreciation of value independently of price. Whether or not the
market is efficient, you will find this perspective engaging.

Negotiating with Mr. Market

Benjamin Graham saw equity investing as a matter of “negotiating with Mr. Market” over
the price to pay. The book shows how to carry out these negotiations. In the spirit of
comparing price with value, analysts typically think of calculating a “true” intrinsic value
for a stock and comparing that to Mr. Market’s price quote. This is not bad thinking but,
with so many uncertainties involved, establishing one true number for the intrinsic value
with confidence is difficult. The book takes a different approach: Understand how earnings
forecasts relate to value, reverse engineer the market price to understand the forecast that
Mr. Market is making, and then challenge that forecast. This recognizes that valuation is
not a game against nature, but rather a game against other investors; one does not have to
find the true value but rather what other investors are thinking. Financial statement analysis
that challenges this thinking is then the focus in the dialogue with Mr. Market.

New to This Edition

This edition of the book emphasizes this theme of challenging market prices. A new chapter,
Chapter 7, applies the valuation models of Chapters 5 and 6 as tools for active investing. The
process is refined in Part Three of the book after the financial statement analysis of Part Two,
for it is this financial statement analysis that elicits the information to evaluate whether
market prices are reasonable. Many of the active investing themes and tools of my recent
book, Accounting for Value (Columbia University Press, 2011), are elaborated upon in this
edition.
Here are the significant changes for the fifth edition, now running to 20 chapters rather
than 19:
• The new Chapter 7—“Valuation and Active Investing”—has been added to Part One of the
book.
• Chapters 5 and 6 on valuation have been written more succinctly with some of the material
moved to the new Chapter 7.
• Material in all chapters has been updated to incorporate new accounting standards.
• Comparisons between U.S. GAAP accounting and international (IFRS) accounting are
made where relevant.
• Examples, illustrations, and graphical material have been updated, now current as of 2010.
• New cases have been added to a number of chapters and the cases in earlier editions have
been updated to 2010.
• New end-of-chapter exercises have been added.
• Chapter 15 (previously Chapter 14) on simple forecasting and valuation has been
extensively revised and simplified.
• Chapter 19 on risk and return in equity investing returns to the theme of active investing.
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x Preface

When I wrote the first edition of this book (in 1999), world equity markets were
experiencing what, in retrospect, is seen as a market bubble. The book was couched in
terms of challenging the high price-earnings and price-to-book ratios at that time with
fundamental analysis. The episode is an important historical lesson in overvaluation, so that
perspective continues in this edition, beginning in Chapter 1. But since then we have
experienced not only the bursting of that bubble, but also a credit crisis and a plunge in
stock prices, with price multiples now lower than historical benchmarks. This edition thus
emphasizes that the analysis techniques it offers are just as applicable to challenging
underpricing as well as overpricing. It also warns of the risk of investing in uncertain times
and points out that, just as bubbles can perpetuate for some time, so can depressed prices.

The Overview
Chapter 1 introduces you to financial statement analysis and fundamental analysis, and sets
the stage for the rest of the book. Chapter 2 introduces you to the financial statements. The
remainder of the book is in five parts:
• Part One (Chapters 3–7) develops the thinking that is necessary to perform fundamental
analysis. It integrates finance concepts with accounting concepts and shows you how the
structure of accounting can be exploited for valuation analysis. Good thinking about
valuation is captured in a valuation model, so this part of the book introduces accrual-
accounting valuation models that provide the framework for the practical analysis that follows
in the rest of the book. Alternative models are discussed as competing technologies, so you
develop an appreciation of the strength and weaknesses of alternative approaches. Part One
ends with an application of these models to active investing.
• Part Two (Chapters 8–13) lays out the financial statement analysis that identifies value
generation in a business and provides information for forecasting. In this part of the
book you will see the lens being focused on the business.
• Part Three (Chapters 14–16) deals with forecasting. The value of a firm and its shares
is based on the payoffs it is expected to yield investors; thus, using the information from
the financial statement analysis, this part of the book shows you how to forecast payoffs.
The forecasting is developed within a financial statement framework so that forecasting
is an exercise in pro forma financial statement analysis. The analysis then shows how to
convert forecasts into valuations of firms and their strategies.
• Part Four (Chapters 17 and 18) deals with accounting issues that arise with the use of
accounting-based valuation. It shows how to accommodate different accounting
methods for measuring earnings and how to analyze the quality of the accounting used
in financial statements.
• Part Five (Chapters 19 and 20) lays out the fundamental analysis of risk, both equity
risk and credit risk, and provides a pro forma analysis that integrates equity analysis and
credit analysis. Here, again, the emphasis is on active investing: How does the investor
handle risk in investing, particularly the risk of paying too much?

PUTTING IT ALL TOGETHER:

A TOOLKIT FOR ANALYSTS AND MANAGERS
The best way to tackle this book is to see yourself as putting together a Toolkit for
analyzing financial statements and valuing businesses and business strategies. As a
professional analyst or business planner, you want to be using the best technologies
available, to get an edge on the competition. So approach the book in the spirit of sorting
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Preface xi

out what are good methods and what are poor ones. You require methods that are practical
as well as conceptually sound.
As you read the text, you find answers to the following questions:
• How are fundamental values (or “intrinsic values”) estimated?
• How does one pull apart the financial statements to get at the relevant information to
value equities?
• What is the relevance of cash flows? Of dividends? Of book values? How are these
measures treated in a valuation?
• What is growth? How does one analyze growth? How does one value a growth firm?
• What are the pitfalls in buying growth?
• How does one challenge the growth expectations implicit in stock prices?
• How does ratio analysis help in valuation?
• How does profitability tie into valuation?
• How does one analyze the quality of financial reports?
• How does one deal with the accounting methods used in financial statements?
• How is financial analysis developed for strategy and planning?
• What determines a firm’s P/E ratio? How does one calculate what the P/E should be?
• What determines a firm’s market-to-book (P/B) ratio? How does one calculate what the
P/B should be?
• How does one evaluate risk? For equity? For debt?
• How does one evaluate an equity research report? What does a good one look like?
• How does one trade on fundamental information?

USING THE BOOK

Background Requirements
To comprehend the text material, you should have a basic course in financial accounting
and a basic course in finance. A second course in financial accounting and a course in
investments or corporate finance will be helpful but not necessary. Indeed, you may find
yourself motivated to take those courses after reading this book.

Chapter Features
The text is written with features designed to enhance your efforts in learning the material. Each
chapter of the book begins with a flow chart that lays out the material covered in the chapter and
connects that material to the preceding and upcoming chapters. This chart will help you see
clearly where you’ve been and where you are going, and how it all ties together. Each chapter also
opens with TheAnalyst’s Checklist, which has two lists: one covering the conceptual points in
the chapter and the other a set of tasks that you should be able to perform after working the
chapter. This outlines the goals of the chapter, setting you up for mastery of the material at hand.
Each chapter concludes with TheAnalyst’s Toolkit, a convenient resource complete with page
references, that summarizes the analysis tools in the chapter—ideal for studying and review.

End-of-Chapter Material
Each chapter ends with a set of concept questions, exercises, and minicases. Working through
this material will enhance your understanding considerably. These problems are designed, not
so much to test you, but to further your learning with practical analysis. Each problem makes
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xii Preface

a point. Concept questions reinforce the thinking in the chapter. Exercises apply methods
covered in the chapter. Drill Exercises lead you gently into the analysis. Applications focus
on issues involving specific companies. Minicases, designed for classroom discussion, are
more contextual and involve a broader set of issues, some involving ambiguity. They are
written more concisely than full cases so that you do not have to handle a large amount of
detail, and classroom time is used more efficiently to make the point. However, the minicases
involve considerable analysis and insight, providing stimulus for group discussion.
As with the chapter material, the Exercises and Minicases often use the same real world
companies to make different points in different parts of the book. To help you refer back to
earlier material on the same company, the Exercises and Minicases are marked with an
easy-to-identify Real World Connection tagline.

The Continuing Case

A continuing case for one company—Kimberly-Clark Corporation—weaves its way
through the book. At the end of each chapter (through Chapter 16), you receive a new
installment of the case which shows how the principles and methods in that chapter are
applied to Kimberly-Clark and build on the analysis of previous chapters. By the end, you
have a demonstration of the application of the book, in total, to one company as a model for
other companies. Work the case, then check your solution against that on the book’s Web site.

Web Site Reinforcement

The material in the text is supplemented with further analysis on the book’s Web site
at www.mhhe.com/penman5e. The Student Center on the Web site contains the following:
• Chapter supplements for each chapter in the book. The flow chart at the beginning of
each chapter of the text refers you to the Web site, and The Web Connection at the end
of each chapter summarizes what you will find in the supplements.
• Solutions to the Continuing Case.
• Additional exercises for each chapter, along with solutions. Work these exercises and
correct yourself with the solutions to reinforce your learning.
• Accounting Clinics I–VII review accounting issues that are particularly relevant to
equity and credit analysis. Among the topics covered are accrual accounting, fair value
and historical cost accounting, accounting for debt and equity investments, accounting
for stock compensation, pension accounting, and the accounting for taxes.
• Build Your Own Analysis Product (BYOAP) on the Web site shows you how to build
your own financial statement analysis and valuation spreadsheet product using the
principles and methods in the book. It is not a final product that you can immediately
appropriate; rather it is a guidebook for constructing your own. As such, it is a learning
device; rather than mechanically applying a black-box product, you learn by doing. With
the completed product you can analyze financial statements; forecast earnings, residual
earnings, abnormal earnings growth, cash flows, and dividends; and then value firms and
strategies with a variety of techniques. Add your own bells and whistles. In short, the
product is the basis for preparing an equity research report and for carrying out due
diligence as a professional. You will find the building process will give you a feeling of
accomplishment, and the final product—of your own construction—will be a valuable
tool to carry into your professional life or to use for your own investing. Spreadsheet
engines for specific tasks are available in the chapter supplements on the Web page for
each chapter. Off-the-shelf products are also available. eVal 2000, authored by Russell
Lundholm and Richard Sloan, is available through McGraw-Hill/Irwin. Also check out
pen25311_fm_i-xxvii.qxd 2/2/12 4:20 PM Page xiii

Preface xiii

the spreadsheet tool of Dan Gode and James Ohlson, at www.godeohlson.com, that
more closely follows the scheme in this book.
• Links to firms’ financial statements and to many other sources of financial information.
You will also find engines to screen and analyze stocks and to help you build your own
analysis tools.
• Market Insight (Educational Version) from Standard & Poor’s contains financial
information on 370 companies. Access codes are available from your instructor.

Resources for Instructors

The book is accompanied by ancillaries that support the teaching and learning. The
Instructor Center on the book’s Web site contains the following:
• Solutions Manual with detailed solutions to the end-of-chapter material.
• Teaching Notes with advice for teaching from the book, alternative course outlines, a
number of teaching tools, and a commentary on each chapter of the book.
• PowerPoint slides for each chapter.
• Test Bank containing further problems and exercises.
• Accounting Clinics to cover the accounting issues in the book in more detail.
• Chapter Notes for each chapter.
pen25311_fm_i-xxvii.qxd 2/2/12 4:20 PM Page xiv

Acknowledgments

This book capsulates what I have learned as a student of the subject. I am indebted to many
writers and professors for that learning. The book has the investment philosophy of
Graham, Dodd, and Cottle’s Security Analysis, the book assigned for my first finance course
as an undergraduate. It also incorporates the accounting concepts from my study of
accounting theory at the University of Queensland and from reading the classics of Paton
and Littleton, Sprouse and Moonitz, and Edwards and Bell, to name a few. It reflects my
training in the principles of “modern finance,” first as a graduate student at the University
of Chicago and subsequently from colleagues at Berkeley.
I have learned much from carrying out research on accounting and valuation. In
seminars, workshops, and informal discussions, I have been stimulated by the insights of
many colleagues at universities around the world. I have a particular debt to Jim Ohlson,
whose theoretical work on accounting valuation models has inspired me, as have our many
conversations on research and teaching. I am also indebted to my students at Berkeley, the
London Business School, and Columbia University, who have worked with draft versions
of this book and given me valuable feedback. Peter Easton and his students at The Ohio
State University, the University of Melbourne, and the University of Chicago also used
drafts of the first edition and were generous with their comments.
My appreciation also goes to Lorraine Seiji at Berkeley, whose dedication to preparing the
manuscript for the first edition was outstanding. Terrence Gabriel and Clarissa Peña at
Columbia provided similar support for this edition. Luis Palencia, Doron Nissim, Nir Yehuda,
Paul Tylkin, and Mingcherng Deng have helped in preparing the graphical material for the
various editions, and Feng Chen, Mingcherng Deng, Guohua Jiang, Siyi Li, and Nir Yehuda
provided valuable accuracy checking and help with supporting materials. To them all I
am grateful. Nancy Banks, as always, gave strong support. The administrations at Berkeley,
the London Business School, and the Columbia Business School, and my colleagues at these
schools, lent support at various stages of the book’s preparation. The entire team at McGraw-
Hill/Irwin have been outstanding. Stewart Mattson has overseen the development of the book
with an expert hand. Instructors, too many to mention, gave feedback on their experience with
earlier editions.
Anonymous reviewers of the various editions went out of their way to help improve the
manuscript. I am very thankful to them. Now identified, they are listed below. Bruce
Johnson requires special mention. He went through the manuscript for the first edition word
by word, challenged it, and persuaded me to make numerous improvements.

Pervaiz Alam Agnes Cheng

Kent State University University of Houston
Holly Ashbaugh Michael Clement
University of Wisconsin, Madison University of Texas at Austin
Scott Boylan Richard Dumont
Washington and Lee University Post University
Shelly Canterbury Peter Easton
George Mason University The Ohio State University

xiv
pen25311_fm_i-xxvii.qxd 2/2/12 4:20 PM Page xv

Acknowledgments xv

Jocelyn Evans Jane Ou

College of Charleston Santa Clara University
Patricia Fairfield Richard Sloan
Georgetown University University of Michigan
John Giles Lenny Soffer
North Carolina State University, Raleigh Northwestern University
Greg Sommers
Richard Gore
Southern Methodist University
Boise State University
Theodore Sougiannis
Bruce Johnson
University of Illinois
University of Iowa
Carolyn Spencer
Sok-Hyon Kang
Dowling College
George Washington University
Thomas Stober
Sungsoo Kim
University of Notre Dame
Rutgers University, Camden
K. R. Subramanyan
Charles Lee
University of Southern California
Cornell University
Gary Taylor
Yong Lee
University of Alabama
University of Houston at Victoria
Mark Trombley
Gerald Lobo
University of Arizona
Syracuse University
James Wahlen
G. Brandon Lockhart
Indiana University
University of Nebraska, Lincoln
Clark Wheatley
Ronald King
Florida International University, Miami
Washington University
Scott Whisenant
Arijit Mukherji
University of Houston
University of Minnesota
Lin Zheng
David Ng
Mercer University, Atlanta
Cornell University, Ithaca

Stephen H. Penman
Columbia University
pen25311_fm_i-xxvii.qxd 2/2/12 4:20 PM Page xvi
pen25311_fm_i-xxvii.qxd 2/2/12 4:20 PM Page xvii

Brief Contents
List of Cases xxv PART THREE
List of Accounting Clinics xxvi Forecasting and Valuation Analysis 434
1 Introduction to Investing and Valuation 2 14 The Value of Operations and the
Evaluation of Enterprise Price-to-Book
2 Introduction to the Financial Ratios and Price-Earnings Ratios 436
Statements 32
15 Anchoring on the Financial Statements:
Simple Forecasting and Simple
PART ONE Valuation 480
Financial Statements and Valuation 72
16 Full-Information Forecasting, Valuation,
3 How Financial Statements and Business Strategy Analysis 504
Are Used in Valuation 74
4 Cash Accounting, Accrual PART FOUR
Accounting, and Discounted Cash
Accounting Analysis and Valuation 552
Flow Valuation 110
17 Creating Accounting Value and
5 Accrual Accounting and Valuation:
Economic Value 554
Pricing Book Values 140
18 Analysis of the Quality
6 Accrual Accounting and Valuation:
of Financial Statements 590
Pricing Earnings 178
7 Valuation and Active Investing 210 PART FIVE
The Analysis of Risk and Return 640
PART TWO 19 The Analysis of Equity Risk
The Analysis of Financial Statements 232 and Return for Active Investing 642
8 Viewing the Business Through 20 The Analysis of Credit Risk
the Financial Statements 234 and Return 680
9 The Analysis of the Statement
of Shareholders’ Equity 258 APPENDIX
10 The Analysis of the Balance A Summary of Formulas 709
Sheet and Income Statement 292
11 The Analysis of the Cash Flow INDEX 725
Statement 342
12 The Analysis of Profitability 364
13 The Analysis of Growth and
Sustainable Earnings 392

xvii
pen25311_fm_i-xxvii.qxd 2/2/12 4:20 PM Page xviii

Contents

List of Cases xxv The Income Statement 36

The Cash Flow Statement 40
List of Accounting Clinics xxvi
The Statement of Shareholders’ Equity 40
The Footnotes and Supplementary
Chapter 1 Information to Financial Statements 41
Introduction to Investing and Valuation 2 The Articulation of the Financial Statements:
How the Statements Tell a Story 42
Investment Styles and Fundamental Analysis 3
Measurement in the Financial Statements 44
Bubble, Bubble, Toil, and Trouble 6
The Price-to-Book Ratio 44
How Bubbles Work 7
Measurement in the Balance Sheet 46
Analysts During the Bubble 8
Measurement in the Income Statement 46
More Toil and Trouble 8
The Price-Earnings Ratio 50
Fundamental Analysis Anchors Investors 9
Accounting as an Anchor: Don’t Mix
The Setting: Investors, Firms, Securities,
What You Know with Speculation 51
and Capital Markets 10
Tension in Accounting 53
The Business of Analysis:
Accounting Quality 54
The Professional Analyst 12
Summary 55
Investing in Firms: The Outside Analyst 12
The Web Connection 55
Investing Within Firms: The Inside Analyst 13
Key Concepts 56
The Analysis of Business 14
The Analyst’s Toolkit 57
Strategy and Valuation 15
A Continuing Case: Kimberly-Clark Corporation 57
Mastering the Details 16
Concept Questions 63
The Key Question: Sustainability
Exercises 63
of Competitive Advantage 17
Minicase 69
Financial Statements: The Lens on
the Business 17
Choosing a Valuation Technology 18
PART ONE
Guiding Principles 18 FINANCIAL STATEMENTS
Anchoring Value on the Financial Statements 20 AND VALUATION 72
How to Use This Book 21
An Outline of the Book 21 Chapter 3
The Web Connection 22 How Financial Statements
Key Concepts 22 Are Used in Valuation 74
A Continuing Case: Kimberly-Clark Corporation 24
The Analyst’s Checklist 75
Concept Questions 27
Multiple Analysis 76
Exercises 28
The Method of Comparables 76
Minicase 30
Screening on Multiples 79
Chapter 2 Asset-Based Valuation 82
Fundamental Analysis 84
Introduction to the Financial Statements 32
The Process of Fundamental Analysis 85
The Analyst’s Checklist 33 Financial Statement Analysis, Pro Forma
The Form of the Financial Statements 34 Analysis, and Fundamental Analysis 86
Introducing Nike, Inc. 34 The Architecture of Fundamental Analysis:
The Balance Sheet 34 The Valuation Model 87
xviii
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Contents xix

Terminal Investments and Going-Concern Prototype Valuations 142

Investments 88 Valuing a Project 142
Valuation Models for Terminal Investments 89 Valuing a Savings Account 143
Valuation Models for Going-Concern The Normal Price-to-Book Ratio 144
Investments 91 A Model for Anchoring Value on Book Value 145
Criteria for a Practical Valuation Model 91 Residual Earnings Drivers
What Generates Value? 92 and Value Creation 147
Valuation Models, the Required Return, A Simple Demonstration and a
and Asset Pricing Models 96 Simple Valuation Model 150
Summary 97 Applying the Model to Equities 151
The Web Connection 97 The Forecast Horizon and the
Key Concepts 98 Continuing Value Calculation 152
The Analyst’s Toolkit 99 Beware of Paying Too Much for Growth 155
A Continuing Case: Kimberly-Clark Corporation 99 Converting Analysts’ Forecasts
Concept Questions 100 to a Valuation 156
Exercises 101 Build Your Own Valuation Engine 157
Minicases 104 Applying the Model to Projects and Strategies 159
Appendix The Required Return and Features of the Residual Earnings Valuation 161
Asset Pricing Models 106 Book Value Captures Value and Residual
Earnings Captures Value Added to
Chapter 4 Book Value 161
Cash Accounting, Accrual Accounting, Protection from Paying Too Much for
and Discounted Cash Flow Valuation 110 Earnings Generated by Investment 162
Protection from Paying Too Much
The Analyst’s Checklist 111
for Earnings Created by the Accounting 163
The Dividend Discount Model 111
Capturing Value Not on the Balance
The Discounted Cash Flow Model 114
Sheet—for All Accounting Methods 164
Free Cash Flow and Value Added 117
Residual Earnings Are Not Affected by
The Statement of Cash Flows 119
Dividends, Share Issues, or Share
The Cash Flow Statement under IFRS 122
Repurchases 165
Forecasting Free Cash Flows 123
What the Residual Earnings Model Misses 165
Cash Flow, Earnings, and Accrual Accounting 124
The Web Connection 165
Earnings and Cash Flows 124
Summary 165
Accruals, Investments, and the
Key Concepts 166
Balance Sheet 127
The Analyst’s Toolkit 166
Summary 129
A Continuing Case: Kimberly-Clark Corporation 167
The Web Connection 129
Concept Questions 167
Key Concepts 130
Exercises 168
The Analyst’s Toolkit 130
Minicases 173
A Continuing Case: Kimberly-Clark Corporation 131
Concept Questions 131
Exercises 132 Chapter 6
Minicase 138 Accrual Accounting and Valuation:
Pricing Earnings 178
Chapter 5
The Analyst’s Checklist 179
Accrual Accounting and Valuation:
The Concept Behind the Price-Earnings Ratio 179
Pricing Book Values 140 Beware of Paying Too Much for Earnings
The Analyst’s Checklist 141 Growth 180
The Concept Behind the Price-to-Book Ratio 141 From Price-to-Book Valuation to
Beware of Paying Too Much for Earnings 141 P/E Valuation 180
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xx Contents

Prototype Valuation 181 A Continuing Case: Kimberly-Clark Corporation 223

The Normal Forward P/E Ratio 183 Concept Questions 224
The Normal Trailing P/E Ratio 184 Exercises 225
A Poor P/E Model 185 Minicases 229
A Model for Anchoring Value on Earnings 185
Measuring Abnormal Earnings Growth 187
A Simple Demonstration and a Simple PART TWO
Valuation Model 188 THE ANALYSIS OF FINANCIAL
Anchoring Valuation on Current Earnings 189 STATEMENTS 232
Applying the Model to Equities 190
Converting Analysts’ Forecasts
to a Valuation 191 Chapter 8
Build Your Own Valuation Engine 192 Viewing the Business Through
Features of the Abnormal Earnings the Financial Statements 234
Growth Model 194
The Analyst’s Checklist 235
Buy Earnings 195
Business Activities: The Cash Flows 236
Abnormal Earnings Growth Valuation
The Reformulated Cash Flow Statement 240
and Residual Earnings Valuation 195
The Reformulated Balance Sheet 241
Abnormal Earnings Growth
Business Activities: All Stocks and Flows 242
Is Not Affected by Dividends,
The Reformulated Income Statement 243
Share Issues, or Share Repurchases 196
Accounting Relations That Govern
Accounting Methods and Valuation 196
Reformulated Statements 243
The Fed Model 197
The Sources of Free Cash Flow and the
PEG Ratios 199
Disposition of Free Cash Flow 244
Summary 200
The Drivers of Dividends 244
The Web Connection 201
The Drivers of Net Operating Assets
Key Concepts 201
and Net Indebtedness 245
The Analyst’s Toolkit 201
Tying It Together for Shareholders:
A Continuing Case: Kimberly-Clark Corporation 202
What Generates Value? 246
Concept Questions 202
Build Your Own Analysis Engine 248
Exercises 203
Summary 250
Minicase 208
The Web Connection 250
Key Concepts 251
Chapter 7 The Analyst’s Toolkit 251
Valuation and Active Investing 210 A Continuing Case: Kimberly-Clark Corporation 252
Concept Questions 252
The Analyst’s Checklist 211
Exercises 253
How the Fundamental Investor Operates 211
Common Misconceptions About Valuation 211
Applying Fundamental Principles 213 Chapter 9
Challenging Speculation in the Market Price 213
The Analysis of the Statement
Reverse Engineering the S&P 500 215
of Shareholders’ Equity 258
Challenging the Price of a Stock 218
Reverse Engineering with the Abnormal The Analyst’s Checklist 259
Earnings Growth Model 221 Reformulating the Statement of Owners’ Equity 259
Build Your Own Active Investing Tool 222 Running with Nike 260
The Web Connection 222 Reformulation Procedures 260
Summary 222 Dirty-Surplus Accounting 263
Key Concepts 223 Comprehensive Income Reporting
The Analyst’s Toolkit 223 Under U.S. GAAP and IFRS 265
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Ratio Analysis 266 Chapter 11

Payout and Retention Ratios 266
The Analysis of the Cash Flow Statement 342
Shareholder Profitability 267
Growth Ratios 267 The Analyst’s Checklist 343
Hidden Dirty Surplus 268 The Calculation of Free Cash Flow 343
Issue of Shares in Operations 268 GAAP Statement of Cash Flows and
Issue of Shares in Financing Activities 272 Reformulated Cash Flow Statements 345
Handling Diluted Earnings per Share 272 Reclassifying Cash Transactions 346
Share Transactions in Inefficient Markets 274 Tying It Together 351
The Eye of the Shareholder 275 Cash Flow from Operations 353
Build Your Own Analysis Engine 276 Summary 355
Accounting Quality Watch 276 The Web Connection 355
The Web Connection 278 Key Concepts 356
Summary 278 The Analyst’s Toolkit 356
Key Concepts 278 A Continuing Case: Kimberly-Clark Corporation 356
The Analyst’s Toolkit 279 Concept Questions 357
A Continuing Case: Kimberly-Clark Corporation 280 Exercises 357
Concept Questions 281 Minicase 362
Exercises 282
Minicase 288 Chapter 12
The Analysis of Profitability 364
Chapter 10 The Analyst’s Checklist 365
The Analysis of Return on Common Equity 365
The Analysis of the Balance
First-Level Breakdown: Distinguishing Financing
Sheet and Income Statement 292 and Operating Activities and the Effect
The Analyst’s Checklist 293 of Leverage 366
Reformulation of the Balance Sheet 293 Financial Leverage 366
Issues in Reformulating Balance Sheets 294 Operating Liability Leverage 368
Strategic Balance Sheets 301 Summing Financial Leverage and
Reformulation of the Income Statement 303 Operating Liability Leverage Effects on
Tax Allocation 304 Shareholder Profitability 370
Issues in Reformulating Income Return on Net Operating Assets and
Statements 308 Return on Assets 371
Value Added to Strategic Balance Sheets 312 Financial Leverage and
Residual Income from Operations 312 Debt-to-Equity Ratios 373
Comparative Analysis of the Balance Sheet Second-Level Breakdown: Drivers
and Income Statement 314 of Operating Profitability 373
Common-Size Analysis 315 Third-Level Breakdown 376
Trend Analysis 316 Profit Margin Drivers 376
Ratio Analysis 318 Turnover Drivers 376
Build Your Own Analysis Engine 321 Key Drivers 379
Summary 321 Borrowing Cost Drivers 380
The Web Connection 322 Build You Own Analysis Engine 381
Key Concepts 322 The Web Connection 382
The Analyst’s Toolkit 323 Summary 382
A Continuing Case: Kimberly-Clark Corporation 324 Key Concepts 382
Concept Questions 325 The Analyst’s Toolkit 383
Exercises 325 A Continuing Case: Kimberly-Clark Corporation 383
Minicases 334 Concept Questions 384
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xxii Contents

Exercises 385 A Modification to Residual Earnings Forecasting:

Minicase 391 Residual Operating Income 438
The Drivers of Residual Operating Income 441
Chapter 13 A Modification to Abnormal Earnings
Growth Forecasting: Abnormal Growth
The Analysis of Growth and
in Operating Income 443
Sustainable Earnings 392 Abnormal Growth in Operating Income and
The Analyst’s Checklist 393 the “Dividend” from Operating Activities 443
What Is Growth? 393 Eye on the Future: Sustainable Income 445
Warnings About Growth 394 The Cost of Capital and Valuation 445
Cutting to the Core: Sustainable Earnings 396 The Cost of Capital for Operations 446
Core Operating Income 396 The Cost of Capital for Debt 447
Issues in Identifying Core Operating Income 397 Operating Risk, Financing Risk, and the
Core Operating Profitability 404 Cost of Equity Capital 448
Core Borrowing Cost 406 Financing Risk and Return and the
Analysis of Growth 407 Valuation of Equity 450
Growth Through Profitability 407 Leverage and Residual Earnings Valuation 450
Operating Leverage 408 Leverage and Abnormal Earnings Growth
Analysis of Changes in Financing 409 Valuation 451
Analysis of Growth in Shareholders’ Equity 409 Leverage Creates Earnings Growth 456
Growth, Sustainable Earnings, and the Evaluation Debt and Taxes 459
of P/B Ratios and P/E Ratios 411 Mark-to-Market Accounting: A Tool for
How Price-to-Book Ratios and Incorporating the Liability for Stock
Trailing P/E Ratios Articulate 411 Options in Valuation 461
Trailing Price-Earnings Ratios Enterprise Multiples 463
and Transitory Earnings 414 Enterprise Price-to-Book Ratios 463
P/E Ratios and the Analysis of Enterprise Price-Earnings Ratios 465
Sustainable Earnings 416 Summary 468
Price-to-Book and Growth 416 The Web Connection 468
Summary 417 Key Concepts 469
The Web Connection 417 The Analyst’s Toolkit 469
Key Concepts 418 A Continuing Case: Kimberly-Clark Corporation 470
The Analyst’s Toolkit 419 Concept Questions 471
A Continuing Case: Kimberly-Clark Corporation 419 Exercises 472
Concept Questions 420 Minicase 477
Exercises 421
Minicases 425
Chapter 15
Anchoring on the Financial Statements:
PART THREE Simple Forecasting and Simple
FORECASTING AND VALUATION Valuation 480
ANALYSIS 434 The Analyst’s Checklist 481
Simple Forecasts and Simple Valuations 482
Chapter 14 Introducing PPE, Inc. 482
The Value of Operations and the The No-Growth Forecast and Valuation 483
The Growth Forecast and Valuation 484
Evaluation of Enterprise Price-to-Book
Simple Forecasting: Adding information to
Ratios and Price-Earnings Ratios 436
Financial Statement Information 488
The Analyst’s Checklist 437 Weighed-Average Forecasts of Growth 488
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Simple Valuations with Short-Term PART FOUR

and Long-Term Growth Rates 488
ACCOUNTING ANALYSIS
Growth in Sales as a Simple Forecast
AND VALUATION 552
of Growth 489
Information in Analysts’ Forecasts 490
Chapter 17
Simple Valuation as an Analysis Tool 491
Sensitivity Analysis 491 Creating Accounting Value and
Reverse Engineering to Challenge Economic Value 554
the Market Price 491 The Analyst’s Checklist 555
Summary 492 Value Creation and the Creation
The Web Connection 493 of Residual Earnings 555
Key Concepts 493 Accounting Methods, Price-to-Book Ratios,
The Analyst’s Toolkit 493 Price-Earnings Ratios, and the Valuation
A Continuing Case: Kimberly-Clark Corporation 494 of Going Concerns 558
Concept Questions 494 Accounting Methods with a Constant
Exercises 494 Level of Investment 558
Minicases 500 Accounting Methods with a Changing
Level of Investment 561
Chapter 16 An Exception: LIFO Accounting 565
Full-Information Forecasting, Valuation, Hidden Reserves and the Creation of Earnings 566
and Business Strategy Analysis 504 Conservative and Liberal Accounting
in Practice 570
The Analyst’s Checklist 505 LIFO Versus FIFO 571
Financial Statement Analysis: Focusing the Lens Research and Development in the
on the Business 505 Pharmaceuticals Industry 572
1. Focus on Residual Operating Income Expensing Goodwill and Research and
and Its Drivers 506 Development Expenditures 573
2. Focus on Change 507 Liberal Accounting: Breweries and Hotels 574
3. Focus on Key Drivers 514 Profitability in the 1990s 574
4. Focus on Choices Versus Conditions 515 Economic-Value-Added Measures 575
Full-Information Forecasting and Accounting Methods and the Forecast Horizon 575
Pro Forma Analysis 515 The Quality of Cash Accounting and
A Forecasting Template 520 Discounted Cash Flow Analysis 576
Features of Accounting-Based Valuation 525 Growth, Risk, and Valuation 577
Value Generated in Share Transactions 526 Summary 578
Mergers and Acquisitions 527 The Web Connection 579
Share Repurchases and Buyouts 528 Key Concepts 579
Financial Statement Indicators and Red Flags 528 The Analyst’s Toolkit 580
Business Strategy Analysis and Pro Forma Concept Questions 580
Analysis 530 Exercises 581
Unarticulated Strategy 530 Minicase 586
Scenario Analysis 531
The Web Connection 532 Chapter 18
Summary 532 Analysis of the Quality
Key Concepts 533 of Financial Statements 590
The Analyst’s Toolkit 533
A Continuing Case: Kimberly-Clark Corporation 534 The Analyst’s Checklist 591
Concept Questions 534 What Is Accounting Quality? 591
Exercises 535 Accounting Quality Watch 592
Minicases 542 Five Questions About Accounting Quality 593
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xxiv Contents

Cutting Through the Accounting: Strategy and Risk 660

Detecting Income Shifting 594 Discounting for Risk 660
Separating What We Know from Price Risk 661
Speculation 597 Market Inefficiency Risk 661
Prelude to a Quality Analysis 598 Liquidity Risk 664
Quality Diagnostics 600 Inferring Expected Returns for Active Investing 664
Diagnostics to Detect Manipulated Sales 603 Growth-Return Profiles 666
Diagnostics to Detect Manipulation Finessing the Required Return Problem 667
of Core Expenses 604 Evaluating Implied Expected Returns with
Diagnostics to Detect Manipulation Value-at-Risk Profiles 667
of Unusual Items 612 Investing Within Risk Classes 668
Detecting Transaction Manipulation 614 Beware of Paying for Risky Growth 668
Core Revenue Timing 614 Expected Returns in Uncertain Times 670
Core Revenue Structuring 614 Summary 670
Core Expense Timing 615 The Web Connection 671
Releasing Hidden Reserves 615 Key Concepts 671
Other Core Income Timing 616 The Analyst’s Toolkit 672
Unusual Income Timing 616 Concept Questions 672
Organizational Manipulation: Off-Balance- Exercises 672
Sheet Operations 616 Minicase 678
Justifiable Manipulation? 617
Disclosure Quality 617 Chapter 20
Quality Scoring 618 The Analysis of Credit Risk and Return 680
Abnormal Returns to Quality Analysis 620
Summary 621 The Analyst’s Checklist 681
The Web Connection 621 The Suppliers of Credit 681
Key Concepts 621 Financial Statement Analysis for Credit Evaluation 682
Reformulated Financial Statements 682
The Analyst’s Toolkit 622
Short-Term Liquidity Ratios 684
Concept Questions 623
Long-Term Solvency Ratios 686
Exercises 624
Operating Ratios 687
Minicases 633
Forecasting and Credit Analysis 687
Prelude to Forecasting: The Interpretive
PART FIVE Background 687
THE ANALYSIS OF RISK Ratio Analysis and Credit-Scoring 688
AND RETURN 640 Full-Information Forecasting 692
Required Return, Expected Return, and Active
Chapter 19 Debt Investing 695
The Analysis of Equity Risk Active Bond Investing 696
and Return for Active Investing 642 Liquidity Planning and Financial Strategy 696
The Web Connection 697
The Analyst’s Checklist 643
Summary 697
The Required Return and the Expected Return 643
Key Concepts 698
The Nature of Risk 644
The Analyst’s Toolkit 698
The Distribution of Returns 644
Concept Questions 699
Diversification and Risk 648
Exercises 699
Asset Pricing Models 649
Minicase 704
Fundamental Risk 651
Risk to the Return on Common Equity 653 Appendix
Growth Risk 654
Value-at-Risk Profiling 654
A Summary of Formulas 709
Adaptation Options and Growth Options 659 Index 725
Another Random Scribd Document
with Unrelated Content
will take the trouble to correct them, I shall be obliged to you. I
have spent almost the whole of my life at school among girls of my
own age, so, of course, I must know very little of the manners and
customs of the world. I see Crescenz’s simplicity quickly enough, and
to avoid falling into her errors, I try to act differently in every
respect. Now, Crescenz, with all her weaknesses, makes herself
beloved—not more than she deserves, for she is the most amiable
creature in the world, while I am universally disliked. I think,
therefore, that something must be wrong; I have no person whose
advice I can ask. Papa overrates as much as mamma underrates me,
and neither of them understands me at all. Do you remember one
evening mamma’s saying that you, as an unbiassed looker-on, could
judge between us? I refused you as arbitrator then, because I knew
you liked mamma better than me; but I am now willing to accept of
you as judge, Mentor, or whatever you please, for I am convinced
that you only dislike me just enough to see my faults without
exaggerating them; so I promise to bear your corrections with as
much patience as my natural impatience will allow.”
During this speech Hamilton had been leaning against the wall,
endeavouring to look as sage as Hildegarde evidently thought him;
his eyes were bent on the ground, but a smile of ineffable
satisfaction played round his mouth. Not for a moment did he
hesitate to undertake the dangerous task. He would direct her
studies, correct her faults, and make her mind as perfect as her
form! What words he made use of to express this most
magnanimous resolution he himself never could recollect; that he
had spoken intelligibly was evident, for Hildegarde held out her hand
and smiled brilliantly as she once more turned to the door. “I think,”
she said, with some hesitation, “I think I could sleep more soundly
to-night if you would begin your office at once, and tell me what I
have done to-day that is reprehensible.”
“I must of course, if you desire it.”
“Let me guess. It is not Oscar’s defence?”
“No; we have already discussed that subject,” replied Hamilton.
 “My—my losing my temper this evening, when mamma made the
remark about Oscar’s saying she was his aunt?”
Hamilton shook his head.
“Well, then, my obstinacy about reading the book?”
“Humph!—obstinacy is certainly a fault, but was not what I meant
on the present occasion.”
“Ah! now I know—because I asked you for a candle, and as I did
not tell mamma I could get one from you, you think that I have
acted dishonourably? Perhaps you are right, so I shall not take it,
but go to bed in the dark as a punishment. Are you satisfied?”
“I ought to be, for you have not only confessed your fault, but
imposed penance on yourself; and yet I must still say that you have
not discovered the error to which I alluded.”
“Then, now you must tell me, for I can think of nothing else.”
“Is it possible,” said Hamilton, the colour as usual, mounting
impetuously to his forehead, “is it possible that you are not aware of
the impropriety of coming to my room at this hour?”
“I—I—came for—for the candle,” stammered Hildegarde, in painful
confusion.
“I know you did; but you have remained here some time, and
people——”
“Let me go—let me go,” she cried, impatiently pushing back the
hand which he had placed on the lock of the door in order to have
time to add a few words. “Let me go; I desire—I insist.”
He drew back, and she rushed past him into the dark passage
without turning round or stopping until she reached the door of her
room. He merely waited until she entered, and then once more sat
down to write.
 CHAPTER XVI.

THE AU FAIR, AND THE SUPPER AT THE BREWERY.

“Will you go with us to the Au fair?” said Madame Rosenberg to

Hamilton, the next day, after dinner.
“Of course, but what is the Au? I never heard of it?”
“One of the suburbs—at the other side of the Isar. There is a
beautiful Gothic church there, which you can look at while I buy
ticking to make Crescenz a mattress.”
“When do we set out?”
“The sooner the better, for the Major has proposed a party to the
Stuberwoll Brewery afterwards; we are to sup there.”
“At the brewery?”
“Yes; the Major says the beer is excellent, and the roast geese
delicious; Rosenberg enjoys the idea, of all things; he has a passion
for roast goose!”
“Oh, what fun!” cried Gustavus, jumping about the room. “Mamma
has promised to take me with her. It is a pity that Fritz has gone to
grandpapa.”
“And may I go too?” asked Peppy.
“You are too young,” replied his brother, demurely; “you cannot
walk so far.”
“I can, I can,” cried Peppy, commencing a roar.
 “Hush,” said Madame Rosenberg; “what is the child crying about?”
“Peppy wishes to go with us, mamma,” said Crescenz; “I will take
charge of him, if you have no objection.”
“You will probably have to carry him half the way home; but you
may do as you please,” replied her mother with a smile of
satisfaction strangely in contradiction to her words. “Off, and get
ready, all of you.”
There was a joyous and noisy rush down the passage, while
Madame Rosenberg, turning to Hamilton, observed: “A very good girl
is Crescenz. She shall not be a loser for liking my boys, that is
certain.”
Madame Rosenberg was herself always the last to appear; she
generally dressed her children, and had a long consultation with her
cook before she went out. Hamilton found the rest of the party, with
the exception of Hildegarde, assembled in the drawing-room, and it
was not long before he observed that Crescenz was making him the
most unaccountable signs and grimaces. He approached her,
apparently occupied in forcing his fingers into a tight glove, and said
in French, “Why are you making such horrible faces?”
Crescenz laughed good-humouredly, but while pretending to look
at his glove, answered hurriedly: “Hildegarde is at the Hoffmanns to
return the book to Count Raimund. Go—go for her before mamma
comes.”
He left the room, descended quickly the flights of stairs, stood
before the Hoffmanns’ apartments, and rang the bell. He now
regretted not having as yet visited them, for though he would have
particularly liked to see how Hildegarde and her cousin were
occupied, he could not make his appearance for the first time so
unceremoniously, and was, therefore, obliged to send in the servant
with a request that Mademoiselle Rosenberg would return home
immediately. He thought he heard Hildegarde speaking as the door
opened, and perceived, from the sound of the moving of chairs, that
she was taking leave at once. Not wishing to be seen, he left the
passage where he had been standing, and retired to the landing-
place on the stairs without. Hildegarde was accompanied by her
cousin, who spoke French, that the servant might not understand
him: “Adieu, dearest Hildegarde; your step-mother may forbid me
her house, but she cannot change the course of nature, and prevent
our being cousins. I shall see you here, and often; promise me that
at least.”
Hildegarde was about to answer, when she perceived Hamilton.
The two young men bowed haughtily, mutual dislike legible in every
feature.
“I suppose I may accompany you to the door, Hildegarde, even if
it be closed against me.”
“It is quite unnecessary,” she replied, moving up the stairs,
evidently endeavouring to get rid of him.
Raimund, however, followed, and, before he turned to descend,
gently took her hand and kissed it, with a mingled expression of
respect and admiration.
Hamilton scarcely waited for him to be out of hearing, before he
observed: “This, I suppose, is the most approved manner for cousins
German.”
“It is less remarkable than the manners of cousins English,” replied
Hildegarde. “I have not forgotten your meeting with yours at
Salzburg.”
“That was after a separation of several months, and——”
“Yes; but it was something more than hand kissing, which means
nothing at all, you know, and, I hear, is rather going out of fashion.”
“And yet it is a pleasant fashion,” said Hamilton. “I never kissed
anyone’s hand, but should have no objection to make a beginning
now.”
Hildegarde held out her hand without a moment’s hesitation.
 “Not that one,” said Hamilton, hesitating; “your cousin’s kiss is still
upon it.”
The door opened suddenly, and she ran laughingly past him
towards the drawing-room, just in time to enter it before her mother.
A few minutes after, they were in the street, Hildegarde, as usual,
close to her father’s elbow, but without taking his arm. Hamilton at
first imagined Mr. Rosenberg’s presence would be a restraint, but he
found, on the contrary, that he encouraged Hildegarde to talk and
give her opinion freely, enjoying even nonsense when it came from
her lips, and laughing with a heartiness which Hamilton had
imagined impossible for a person who had always appeared so calm
and reserved. Everything and everybody who passed afforded
amusement; it was in vain Madame Rosenberg called to order; the
laugh was partly stifled for a moment, to be renewed the next with
double zest. Hamilton was extremely surprised, and began to think
he should never be able to understand her character, and yet the
simple fact was merely, that, being naturally gay, she only required
the certainty of being able to please to induce her to yield to her
innate inclination. She was not herself aware of this, for, on
Hamilton’s making some remark to express his surprise, she said:
“She believed she was only by degrees getting over the restraint of
her school habits, all conversation being forbidden there, excepting
during the recreation hours.”
The crowd at the fair was immense. It was the first time Hamilton
had seen anything of the kind, and he found it difficult to believe
that in the paltry booths around him there could be anything for sale
as good as might be had with less trouble in the town. The noise,
the talking, and the bargaining amused him not a little, especially
the latter; and he stood beside Madame Rosenberg for more than
half an hour, while she haggled about the price of some muslin. At
the end of this time she was at the point of walking off, (or, as she
explained afterwards, pretending to do so,) when the shopman
called her back, and with an assurance that he was giving her the
“article” for next to nothing, prepared to measure what she required.
This was a bargain! She had gained twenty-one kreutzers, about
seven pence, and had the annoyance of carrying a large package
home, for porters there were none. To anyone accustomed to
English tradesmen, the almost positive necessity of bargaining in the
generality of German shops is extremely tiresome and disagreeable.
It is more than probable that the tradesmen would gladly establish
fixed prices, were not the habits of bargaining as yet too strong in
the middle and lower orders to be overcome.
The vociferous invitations of the Jews to inspect their wares were
equally novel to Hamilton. “Ladies, step here, if you please. Cheap
gloves, elegant ribbons, scissors, bracelets, or soap. Have I nothing
that I may show you, madame? Flannels, merinos, or cloth for the
young gentlemen? Winter is coming, madame, and I promise you as
great bargains as you will get anywhere!”
To all these speeches Madame Rosenberg gave an answer,
generally of a facetious description; and while Hamilton thought her
more than usually vulgar, he sometimes could not avoid laughing,
the more so as everything she said was taken in good part, and a
few words seemed to reconcile the vendors to her passing their
booths without purchasing. The two little boys had become weary
and hungry; they leaned against the counters, occasionally upset the
piles of goods ranged outside the booths, cuffed each other when
their mother was not watching them, and when forced to stand
quietly beside her, yawned until the tears ran down their cheeks.
Hamilton took pity on them, and finding a toyshop, soon filled their
pockets and hands with playthings, making them by many degrees
the happiest of the whole party.
“So!” cried Madame Rosenberg, as they returned to her, radiant
with smiles, “this is what you have been about; I thought Mr.
Hamilton had gone to look at the church. We must all go together, it
seems, and the less time we lose there the better, for the days are
short, and we have a long walk home after supper.”
They were not exactly the persons with whom Hamilton could
enjoy seeing anything of the kind, and on entering the church he
walked up the aisle alone. They all, however, followed him, and
Crescenz observed, in a dissatisfied tone of voice, “And is this the
church that everyone admires so much? It is not half so handsome
as the Allerheiligen. I declare, if it were not for the painted windows
with the sun shining through them, I should say it was the most
sombre church I had ever seen.”
“You have seen very few, my dear,” said her father, looking round
him, and drawing nearer Hamilton.
“I have seen all the churches in Munich,” said Crescenz, “and
several of them are larger than this.”
“It would be difficult to form an opinion of the size of this
building,” said Hamilton, thoughtfully, “for the proportions are so
admirably observed that nothing strikes the eye or distinguishes
itself above the rest. There is no point from which one can take a
mental measure, and I am convinced it appears infinitely smaller
than it really is.”
“But I expected to see a quantity of painted pillars, and bright
colours, and gilding, when I heard it was Gothic,” observed
Crescenz.
“I know nothing of architecture,” said Hamilton, turning to Mr.
Rosenberg, “but I form exactly a contrary idea when I hear of a
Gothic church; the painted windows are the only colours which are
admissible without destroying my ideal.”
“And yet,” said Mr. Rosenberg, “Gothic buildings often combined
colour with form. In northern countries, either from stricter simplicity
of taste, or on account of the climate, the absence of colours is
usual, and sculpture takes their place; but in the south, beside the
painted ceilings, mosaics, and frescoes inside, the outsides of the
churches were ornamented with coloured marble. It is a mistake to
suppose that the Gothic and Byzantine architecture refused the
assistance of colours; on the contrary, the most brilliant and strongly
contrasted painting is common. To begin with the windows——”
 “Rather let us dispense with them altogether,” said his wife,
moving towards the door.
“I have no objection,” said Mr. Rosenberg, turning round to look
back into the church, “for they do not suit the grey monotony of the
walls, and the gaudy colours playing so uncertainly on the cold
surface have something, to me, altogether disharmonious. In almost
all the old cathedrals,” he added, “the walls and pillars were formerly
gorgeously painted; and it is only in the later centuries that, either
from want of taste or poverty, they have been whitewashed.”
“I was not aware of that,” said Hamilton. “It cannot, however,
make me change my ideas all at once. A Gothic church is always
handsome, with its light pillars and pointed steeple and windows. I
have never travelled in southern countries, and my taste for bright
colours has not yet been made. Since I have been in Munich, I have
begun merely to tolerate them by degrees; and for this reason
paintings of the Middle Ages do not please me, no matter how
celebrated they may be. I cannot endure the bright red and blue
draperies, or the terribly shining gold backgrounds which are so
common in those pictures. I dare say it is great want of taste on my
part, but the hard outlines appear to be unnatural, and the glaring
colours offensive.”
“Very probably, when viewed deliberately in a picture-gallery; but
exactly these pictures were intended for churches, and churches
with painted walls. You must allow that duller colours would have
appeared weak, or would have been completely lost, when
submitted to the glowing stream of light which would have fallen on
them from windows of blue, red, and amber-coloured glass!”
“All this never occurred to me,” said Hamilton; “but I suspect, as
you so warmly defend these bright colours, that you have seen and
admired them in more southern climes. Have you been in Italy?”
“Many years,” he replied, while a sudden flush passed across his
face.
“Papa has been in Spain and in Greece too,” said Hildegarde.
 “And yet you never speak of your travels!” exclaimed Hamilton,
surprised.
“Because I regret them,” said Mr. Rosenberg, sorrowfully. “I did
not travel expensively, and yet I wasted my whole patrimony and the
best years of my life in foreign countries. I know not what I should
have become at last, had I not by chance met Hildegarde’s mother
in Tyrol.”
“She—she was probably very beautiful,” said Hamilton, glancing
unconsciously towards their companion.
“No,” replied Mr. Rosenberg, thoughtfully. “She was interesting
looking, but no longer young when we married. She was clever and
warm-hearted—like Hildegarde here—and could love with a warmth
perfectly irresistible to a man who had wandered for years, and was
without a friend or near relation in the world. She gave me an object
in life; but her affection, though of incalculable benefit to me,
subjected her to trials and privations which only ended with her life.
I was not worthy of such love!”
“Oh, papa! I am sure you were,” cried Hildegarde, eagerly. “And
what are trials and privations when shared with those we love! It
must be a compensation for everything when one is really loved! I
should like someone to love me—not in a commonplace, rational,
every-day sort of way—but permanently—desperately——”
“My dear girl, you don’t know what you are saying! What will Mr.
Hamilton think of you!”
“He will think I am talking nonsense,” replied Hildegarde, laughing,
“or, perhaps he will not understand me. Mr. Hamilton is much too
rational to love unwisely—and as to passion of desperation, I do not
think it possible for him to form a tolerably correct idea of the
meaning of the words!”
“Hello!” shouted Major Stultz, “where are you three going? We are
all waiting for you, and the roast goose is nearly ready.”
 They turned back and Hildegarde said in a low voice to Hamilton,
as they passed through the yard of the brewery, “I am glad that
there are not many people here, for, though I like a garden party
exceedingly, I think supping in a brewery must be vulgar. I wonder
you came with us!”
“I like to see everything,” replied Hamilton, “and besides a man
may go anywhere and everywhere.”
“Ah, how I should like to be a man!” she said sighing.
“You are too young for such a wish,” said Hamilton; “rather like
the Prince de Linge, desire to be a woman until you are thirty, a
soldier until you are fifty, and to spend the rest of your life as a
monk.”
“I think,” said Madame Rosenberg, bustling past them, “I think
that as the evening air is cool, we had better take possession of the
little room at the end of the garden; there is a window in it which
looks out on the road, and we can see everybody who goes by. Do
you remember, Franz, we supped there with my father on pork-
chops and sauer-kraut the evening before we were married?”
Mr. Rosenberg’s previous conversation seemed to have made him
somewhat oblivious—he confessed having forgotten the pork-chops,
but said that he had probably thought more of her than of them, at
such a time.
“I don’t know that,” said his wife, “for you scarcely spoke a word,
and eat enormously. Now that I think of it, I dare say that was the
reason you looked so miserably ill the next day.”
“I dare say it was,” replied Mr. Rosenberg, rubbing his forehead
hastily, and then turning to little Peppy, who was dragging from his
pocket the toys given him by Hamilton.
“Ah, those are childish things,” cried Gustavus, pushing him aside,
and leaning against his father’s arm, while he endeavoured, with
more haste than dexterity, to open a little wooden box. “Those are
childish things, but here are swans and fish made to follow a
magnet, and they swim about in the water as if they were alive.
Crescenz says I may swim them in her basin to-morrow.”
“Papa, look at my drum,” cried Peppy, in his turn endeavouring to
push aside his brother, “look at the nice large drum which Hamilton
has given me.”
“Say Monsieur de Hamilton, or Herr von Hamilton,” said Madame
Rosenberg; “you and Gustle take great liberties.”
“We have no von in England,” said Hamilton, slightly colouring,
“and if the children may not call me Hamilton, I must teach them my
Christian name.”
“What is your Christian name?” asked Gustle.
“Alfred. I hope you like it?”
“And what is your name?” asked Crescenz, turning to Major Stultz.
“My name is Blazius.”
“Blazes!” cried Hamilton. “What an odd name!”
“Not at all odd,” said Major Stultz, “the name is a good one, to be
found in all almanacks on the third of February, which is my name’s
day. Next year, I expect it to be properly celebrated too—eh,
Crescenz?”
Crescenz as usual smiled, but looked embarrassed, and was
evidently greatly relieved by the entrance of the roast goose and
salad.
They supped, and Mr. Rosenberg and Hamilton had just lit their
cigars, and Major Stultz drawn forth a pocket edition of a
meerschaum pipe, which he prepared to smoke as an
accompaniment to his third tankard of beer, when the sound of a
number of gay loud voices, and approaching steps, made Madame
Rosenberg hastily open the window which looked into the garden,
and stretch her long thin neck to its utmost extent. She seemed half
vexed as she drew back again, exclaiming: “Well, to be sure!
wherever we go—we are sure to see him. If he were alone, I
shouldn’t care a straw; but he will, no doubt, bring all the others
with him.”
“Who?” asked Mr. Rosenberg, very quietly continuing to puff at his
newly-lighted cigar.
“Count Zedwitz, of course—he is always sure to find out where we
are going, and pursues us like a shadow!” replied his wife, glancing
half-suspiciously towards Hildegarde, who, however, sprang from her
chair with even more than her usual vivacity, while she said to
Hamilton: “Can you not assist us to escape? This window is so close
to the ground that I think we could easily leap on the road. Pray
persuade mamma to walk home with us, and leave papa to follow.”
Hamilton threw open the window, and in a moment was on the
ground, holding up his arm towards her; she sprang down lightly
without assistance, the two boys followed, but when it came to
Crescenz’s turn, she drew back, saying she was afraid.
“Oh, Crescenz! choose some other time and some better occasion
for timidity,” cried Hildegarde, impatiently.
“If you cannot jump, make a long step,” said Madame Rosenberg,
laughing, while she put her advice in practice by extending towards
the ground nearly a yard of formless bone, and with Hamilton’s
assistance, and a slight totter, reached the road.
A tremendous clatter of swords in the garden seemed to alarm
Crescenz; she threw herself completely upon Hamilton; and while he
was endeavouring to place her steadily on her feet, the sound of
wheels made him look around. A dark-green open carriage was at
the moment turning round, and in the corner of it, vainly
endeavouring to suppress a fit of laughter, sat A. Z.
Hamilton coloured violently as he approached her, and expressed
his astonishment at seeing her at Munich.
“Herrmann called on you a couple of hours ago,” she replied, “but
you were not at home; and as we only remain a few days here, and
I may not see you again, I must not forget to renew my invitation to
Hohenfels. You must not, however, expect to see an English country-
house, a park, or anything of that kind—prepare yourself for one of
the simplest of German establishments, if you do not wish to be
horribly disappointed. I should like you to see Hohenfels before the
snow comes on, or after it is gone. When will you come to us?”
“In spring, if you please,” said Hamilton, “I have at present so
many engagements——”
“I need not ask you to drive back with me,” she said, looking after
the Rosenbergs, “but I can take those children and leave them at
home—it is a great distance for them to walk.”
Hamilton was the bearer of a message to Madame Rosenberg,
who no sooner heard of the proposal than she turned, back,
approached the carriage, and commenced such a torrent of
exaggerated thanks and apologies, accompanied by curtsies and
bows, that Hamilton, who had lately begun to feel a sincere regard
for her, was vexed, and looked at A. Z. as if to deprecate her mirth,
while he silently lifted the two boys into the carriage.
It was unnecessary. A. Z. seemed to find nothing unusual in
Madame Rosenberg’s manner; and when the latter raised her finger
threateningly, and told the children, “For their life to keep quiet, and
not soil the baroness’s beautiful silk dress,” she replied, quietly, that
“she was well accustomed to such youthful company to be in the
least inconvenienced by a pair of dusty little shoes more or less.”
“An exceedingly civil person,” observed Madame Rosenberg, as the
carriage drew off, “an exceedingly civil person is your
countrywoman. I am sorry we did not get better acquainted at Seon,
for I liked her a great deal better than those Zedwitzes, who were
uncommonly grand, and seemed to think their son demeaned
himself when he spoke to our girls. I did not court his company, I
am sure, and I let him see it.”
“It is hardly just to make him suffer for his parents’ faults of
manner,” said Hamilton; “Zedwitz is extremely gentlemanlike and
good-humoured, and has not a particle of pride in his composition.
Will you not assist me to defend the absent?” he added, turning
somewhat maliciously to Hildegarde.
“My defence would be as injudicious as useless,” she said, but in
so low a voice that only Hamilton could hear her words; “he is
indeed all you have said, and much more—excellent in every
respect, I believe.”
“You do him justice,” began Hamilton, though he would have
preferred praise less warm in its expression; but at this moment they
were overtaken by Mr. Rosenberg and Major Stultz, accompanied, to
the surprise of all, by Count Zedwitz and Count Raimund.
“I have brought you two of the party from whom you ran away,”
said Mr. Rosenberg, laughing, as he joined them. “Count Zedwitz
came into the room just in time to see Crescenz fly out of the
window, and both he and Count Raimund prefer walking home with
us to drinking the superlatively excellent Stuberwoll beer, although I
praised it as it deserved.”
“It was truly delicious,” said Major Stultz. “I should have had no
objection to another glass.”
“Hildegarde! Crescenz!” cried Mr. Rosenberg, “this is your cousin,
Count Raimund.”
Crescenz turned round and blushed. Hildegarde took her usual
place beside her father, while she said, without hesitation, that she
had already made her cousin’s acquaintance at the Hoffmanns’.
Hamilton saw a glance of such meaning pass between them as she
spoke, that he indignantly walked forward towards Madame
Rosenberg. Major Stultz and Crescenz soon joined them; and the
former explained that Count Raimund had, in the free-and-easiest
manner possible, claimed relationship with Mr. Rosenberg. That he
had spoken of his aunt—said that he recollected her perfectly—
hoped he would present him to his cousins and his present wife, and
allow him occasionally to visit his family.
“And Franz was as usual all civility,” said Madame Rosenberg, with
considerable irritation.
 “Why, to tell you the truth, it was not easy to be otherwise,”
replied Major Stultz; “his manner was so off-hand and sincere when
he said that he trusted Rosenberg would not make him a sufferer for
family differences which had occurred when he was a mere child.
They shook hands, and I was obliged to do the same, as he
congratulated me on my approaching marriage, and said——” here
Major Stultz diligently sought for his pocket handkerchief, as he
spoke—“said he was particularly happy at the prospect of being so
nearly allied to an officer of whose personal bravery he had heard so
much—or something to that purport.”
“It is too late to attempt opposition now,” said Madame
Rosenberg. “I intended to have refused his acquaintance, and
forbidden him our house, without ever mentioning his name—it is
now impossible. As to Franz, he has acted exactly as was to be
expected; but after all you said yesterday evening I did not think you
would cultivate his acquaintance, on Crescenz’s account.”
“Crescenz will, I hope, do me the favour not to speak much to
him,” began Major Stultz; but Crescenz interrupted him by
exclaiming, in a voice wavering between crying and laughing:
“I shall really be obliged to talk to myself at last! Every day a new
prohibition!”
“What does the child mean?” said Madame Rosenberg, appealing
to Major Stultz, whose colour visibly deepened. “What on earth does
she mean? Has she not her brothers, her sisters, and you, and Mr.
Hamilton to talk to?”
“No!” cried Crescenz, while tears of vexation started to her eyes,
“he forbid my speaking to Mr. Hamilton before we came out to-day;
and I am sure I don’t know why!”
“Then I must tell you why,” said Major Stultz, restrained anger
evident in the tone of his voice. “It is because I have just begun to
discover that you give yourself a vast deal too much trouble to
please this Mr. Hamilton—your—your vanity is insatiable; and, I must
say, you are the greatest coquette I ever saw!”
 Crescenz burst into tears.
Major Stultz seemed immediately to repent his speech. He
attempted to draw Crescenz’s arm within his, while he commenced
an agitated apology; but she shrank from him, and between
suppressed sobs stammered, “If—if such be your opinion—of me—
the—the sooner we break off our engagement the—the better.”
“Crescenz, are you mad!” cried her step-mother, catching her arm,
but Crescenz broke from her, and hurried on alone.
“Oh, pray, Mr. Hamilton, do have the kindness to talk a little
reason to that headstrong girl,” said Madame Rosenberg, turning to
Hamilton, who had been walking close behind them.
“Excuse me,” he said, quietly. “Now that I know Major Stultz’s
wishes on the subject from himself, he may be quite sure of my not
speaking much to Mademoiselle Crescenz in future. I have no right
whatever to interfere with his claims.”
“We know you never thought of such a thing. Don’t we, Major!”
“Mr. Hamilton certainly admired Crescenz when at Seon,” observed
Major Stultz, sullenly.
“A mere jealous fancy on your part,” said Madame Rosenberg,
eagerly.
“Not quite,” said Hamilton, “I plead guilty to the charge; in fact, I
admire every pretty face I see, and both Mademoiselle Crescenz and
her sister are remarkably handsome.”
“You see Mr. Hamilton treats the whole affair as a joke.”
“It is no joke to me, however—I have been a precipitate fool, and
ought never to have thought of marrying such a girl as Crescenz—
perhaps I do Mr. Hamilton injustice—but——”
“I am sure you do,” cried Madame Rosenberg, interrupting him,
and then touching Hamilton’s elbow, she whispered, “Say something
to him.”
 “What can I say? Major Stultz can hardly expect that because he
intends to marry a very pretty girl, everyone is to find her ugly and
disagreeable, in order not to provoke his jealousy! I can avoid
speaking to her, but I cannot think her one bit less pretty than she
really is.”
“Come now, Mr. Hamilton,” said Madame Rosenberg, jocosely, “I
see you are trying to tease the Major, but you must not go too far, or
he will not understand you. Crescenz is very good-looking, but I
have no doubt you have seen many prettier girls in England.” She
turned towards him once more, and said in a very low voice: “I shall
be greatly obliged if you will say that you admire Hildegarde still
more than her sister.”
Hamilton found no difficulty in complying with her request, and
was so eloquent on the theme given him, that he not only convinced
Major Stultz that he had been mistaken, but induced him even to
banter him on his apparently hopeless love. Madame Rosenberg did
not wait for this result; she no sooner perceived that Hamilton
intended to comply with her request than she walked on beside
Crescenz, and began a severe reprimand. Had she delayed a few
minutes, she would have found the young lady more disposed to
listen to her and profit by her advice.
Unfortunately, Crescenz had overheard what Hamilton had said
before Hildegarde’s name was mentioned, and her mind, buoyed up
on a thousand vague hopes, would not now yield to the pressing
reasonings of her mother; she said sullenly, “that Major Stultz was
intolerably jealous—that his age rendered him unable to make
allowances for younger people, and that he expected more than was
reasonable if he thought she could marry him for any other cause
than in order to obtain a home. She would tell him so the first
convenient opportunity.”
“You will tell him no such thing,” cried Madame Rosenberg, turning
back, in order to try the effect of her eloquence on Major Stultz. She
was a clumsy maneuvrer—but she generally gained her point, for
she always meant well, and at times spoke with much worldly
wisdom. On the present occasion, she took her future son-in-law’s
arm, and walked quickly on with him, leaving Hamilton, to his great
annoyance, with Crescenz. He would willingly have joined the others,
but there were too many to walk abreast, and neither Zedwitz nor
Raimund seemed disposed to resign their places.
They walked together in silence for some time, Crescenz with an
air of triumphant satisfaction, Hamilton with ill-concealed
impatience.
“I hope,” she began at last, “I hope that I have seriously offended
Major Stultz this evening: nothing would give me greater pleasure
than the breaking off of this odious engagement.”
“It would have been more honourable had you done so before you
left Seon.”
“Better late than never,” said Crescenz, gayly.
“To act dishonourably, do you mean?” asked Hamilton, gravely.
“Ah, bah!” cried Crescenz, with imperturbable good-humour. “You
are talking exactly like Hildegarde, now.”
“You are not acting as Hildegarde would,” said Hamilton, still more
seriously.
“Don’t praise her too much, you are out of favour with her just
now, I can tell you.”
“What do you mean?” asked Hamilton, quickly.
“I mean that I am sure you must have been very uncivil to her last
night when you refused her the candle, for she cried a good half-
hour before she went to bed; and Hildegarde does not cry for
nothing! Perhaps if I had gone for the candle, you would have given
it.”
“Perhaps,” answered Hamilton, absently.
“I am sure you would,” she persisted.
“Oh, of course, of course.”
 “Well, I told her so, and wanted to get up and go to you—but she
would not allow me.”
“She was right,” said Hamilton, endeavouring to overtake Madame
Rosenberg, while she was speaking.
“Oh, for heaven’s sake don’t bring me again to mamma! I have
been so lectured by her already—perhaps you heard what she said?”
“No, I was speaking to Major Stultz.”
“And he was so—so very rude to me—you have no idea.”
“He told you some unpleasant truths.”
“Truths!” exclaimed Crescenz.
“Yes, truths,” repeated Hamilton. “You are very pretty, and very
good-natured, but you certainly are a—a coquette—what we call in
England a flirt.”
“Well, how odd!” exclaimed Crescenz. “Do you know—I don’t at all
mind your telling me that—and I was so very angry with him! I
declare now I should like to hear all my faults!”
“I dare say Major Stultz will enumerate them, if you desire it,” said
Hamilton, now determinedly joining Madame Rosenberg, and
remaining beside her the rest of the way home.
 CHAPTER XVII.

LOVERS’ QUARRELS.

The moon was shining brightly on their house, as they lingered in

the street to speak a few parting words. Mademoiselle de Hoffmann
sat at an open window, and gazed pensively upwards.
“Should you not like to know the thoughts of your betrothed at
this moment?” asked Mr. Rosenberg, turning to Raimund.
“Not at all,” he replied, carelessly glancing towards the house, “I
am sure they are commonplace, for a more matter-of-fact person
does not exist than Marie de Hoffmann.”
“So,” cried Zedwitz, “it is really true that you are going to be
married! I am glad to hear it, and congratulate you with all my
heart.”
“Thank you,” said Raimund musingly, while he turned from
Zedwitz to Hamilton, and then to Hildegarde, as if they, and not
Mademoiselle de Hoffmann, occupied his thoughts.
“When is it to take place?” asked Zedwitz.
“What! ah! my execution? Some time in January, they say; I wish
it were sooner.”
“Of course you do,” said Zedwitz, laughing.
“That is,” said Raimund, the colour mounting to his forehead, “I
am afraid, if it be put off long, I shall get tired of the concern, and in
the end prove refractory.”
 Mademoiselle de Hoffmann had recognised and now addressed
them from the window. Raimund was invited to supper, and entered
the house with the Rosenbergs, while Mr. Rosenberg, who never
spent an evening at home, walked off with Zedwitz.
The moonlight was so bright in the drawing-room, that on
entering Madame Rosenberg declared it would be folly to light the
candles. She gave Crescenz a gentle push into the adjoining room,
telling her to “be a good girl, and make up her quarrel with the
Major,” and then went to “look after her boys.”
Hamilton looked out of the window, and hummed an air from Fra
Diavolo.
“I am very tired,” said Hildegarde, taking off her bonnet; “our walk
has been long and dusty: and besides I have talked a great deal,
which is always fatiguing,”—she stood beside and leaned out of the
window with him.
Hamilton’s hum degenerated into a half-suppressed whistle,
accompanied by a drumming on the window-cushion, while his
upturned eyes were fixed on the moon. They remained several
minutes without speaking, until a murmuring of voices from the
window beneath them attracted their attention. Hamilton leaned
farther out to see the speakers, but on recognising Count Raimund
and Mademoiselle de Hoffmann, he drew back with a slightly
contemptuous smile, while he said, “Your cousin’s observations this
evening on his intended bride were by no means flattering.”
“He scarcely knows her yet,” said Hildegarde, seating herself on
the window-stool.
“Scarcely knows the person to whom he is to be married!”
exclaimed Hamilton. “You Germans have the oddest ideas on these
subjects.”
“I see nothing odd in the matter; it is an acknowledged mariage
de convenance. Oscar proposes to marry Mademoiselle de Hoffmann
because he has debts and she has a large fortune; and she accepts
him because she is not very young, and not at all pretty, and wishes
for a good connection; they are not, however, to be married until
January, and are to endeavour in the meantime to like each other as
much as possible. Can anything be more reasonable?”
“Nothing, excepting, perhaps, their having delayed their
engagement until the trial was over. I should like amazingly to know
what the sensations of a man may be who sees, for the first time, a
person to whom he is beforehand engaged to be married. A lady in
such a situation is still more awkwardly placed.”
“There was no awkwardness whatever in this case. Marie was
pointed out to Oscar in the theatre, he did not find that her
appearance was disagreeable, heard that she was amiable, and
consented to marry her. His father made the proposal for him, and
Marie was given a whole week to consider before she was required
to decide.”
“A whole week!” repeated Hamilton, laughing ironically.
Hildegarde rose abruptly, and was about to leave the window,
when he exclaimed, “Excuse my ignorance of German customs. I am
really interested in what you have been telling me, and should like to
know what finally induced Mademoiselle de Hoffmann to accept your
cousin.”
“What induced her! They met at the house of a mutual friend, and
though you do not know how agreeable Oscar can be when he
chooses, you—you must have perceived that he is uncommonly
good-looking.”
“Why, yes, he certainly is not ugly; but good looks on the part of a
man is a matter of minor importance!”
“A handsome face is always an advantage. Don’t you think so?”
asked Hildegarde, laughing.
“An advantage? oh, certainly; but from what you have told me of
Mademoiselle de Hoffmann, I thought her far too rational to attach
much importance to personal advantages. I should have imagined
her just the sort of a person to appreciate a man like Zedwitz.”
 “You do her but justice,” said Hildegarde; “and I think that, were
she given the choice, with time and opportunity to form an opinion,
she would decide in favour of Count Zedwitz; but he has no debts,
requires no fortune, and is not likely to marry in this way; he
certainly will not employ his father as suitor!”
“You seem to know him thoroughly; I was not aware that you had
such an exalted opinion of him until to-day,” said Hamilton, biting his
lip.
“If we had ever spoken of him when mamma was not present, I
should not have hesitated to say that, with the exception of my
father, I do not think there is a more amiable or generous-minded
person in the world than he is.”
Hamilton attempted to smile, in order to hide the jealousy which
at the moment he keenly felt, and answered with affected
eagerness, “Will you allow me to tell Zedwitz what you have said? I
know it will make him inexpressibly happy.”
“No, thank you,” replied Hildegarde, calmly, though even in the
pale moonlight her deep blush was perceptible. “It is equally
unimportant now what he thinks of me or I of him.”
A pause ensued, which was broken by Hamilton saying abruptly,
“If you really think Zedwitz so estimable, may I ask you why you
refused his proposal of marriage the day we were on the alp?”
Hildegarde seemed utterly confounded, and remained silent.
“You may speak without reserve,” added Hamilton, “for Zedwitz
has told me everything.”
“I am not going to speak at all, unless,” she added, half laughing,
“unless you intend to begin your office of mentor; you seem
altogether to have forgotten that you undertook last night to tell me
my faults, and assist me to correct them. Have I done nothing
reprehensible to-day?”
“Yes,” replied Hamilton, “I saw you bestow on your cousin this
evening when he joined us a glance that gave me the idea of a
previous understanding with him——”
“Go on,” said Hildegarde.
“Can you not explain or exculpate yourself?” asked Hamilton with
some embarrassment.
“Oh, of course—but I thought you would naturally say something
about my having bestowed a glance of nearly the same kind on you,
when mamma talked of the pork-chops and my father’s illness the
day of his marriage; that was in fact more reprehensible than the
other, and shall not occur again.” She paused for a moment, and
then continued: “When you came for me to the Hoffmanns’ to-day, I
had just returned that unlucky book of poems to Oscar, and to
prevent an unpleasant scene in our house, I partly told him what
mamma had said—he, however, resolved immediately to try what he
could do with papa, who he knew was too gentlemanlike to be rude
to him. I suppose he overheard me tell Marie where we were going
this evening, and followed—his success was complete, it seems, and
I could not resist the temptation to let him know that I perceived
and was glad of it. What else?” she asked, gayly.
“Your mother seemed to think it was odd that Zedwitz always
knew where you were to spend the evening. Have you ever in any
way let him know, or——”
“Really, this is too much,” cried Hildegarde, angrily; “I will not be
questioned in this manner—or on this subject——”
“You are right,” said Hamilton, quietly, “and I resign my most
absurd office of corrector and improver. You have, however, no just
cause for anger, for you not only proposed the plan yourself, but
reminded me of my promise.” He leaned out of the window, and had
recourse again to Fra Diavolo and the moon.
“You are a horrible tyrant!” she exclaimed after a pause, “and I
suppose, if I leave your question unanswered, you will think me
capable of making Count Zedwitz acquainted with all our walking-
parties!”
 “What matters it what I think?” said Hamilton, without turning
round.
“Your question is exceedingly offensive, and yet I must answer it,
and tell you that I am as much surprised as mamma at meeting him
so often. If I could avoid seeing him, I should greatly prefer it.”
“Indeed!” cried Hamilton. “Then you have no wish to renew the—
the——”
“None whatever,” replied Hildegarde, smiling.
“But if you think so highly of him,” persisted Hamilton, “surely you
must like him!”
“Like him!” she repeated, “why, have I not told you that I like him
exceedingly?”
“Something to that purport, certainly,” said Hamilton; “you are
altogether inexplicable, and I dare not ask an explanation.”
“You have no right,” said Hildegarde; “what occurred before
yesterday does not come under your cognisance.”
“I am completely at fault,” said Hamilton, in a low voice, as if
reasoning with himself. “Zedwitz told me that you had said you liked
him as an acquaintance, but nothing more. This, I know, is not the
case; therefore there must be some misunderstanding—he
suspected a prior attachment, but that seemed to me improbable.”
“Rather say impossible,” cried Hildegarde, laughing, “for the object
of it must have been either Major Stultz—or you! ha, ha, ha!”
Hamilton did not laugh with her, and another long pause ensued—
his jealousy, or, as he to himself termed it, his curiosity, prompted
him to make another effort, and he again began: “I told Zedwitz he
ought not to resign all hope; that probably the fear of opposition on
the part of his family had influenced you.” He stopped, for
Hildegarde bit her lip, and seemed agitated. She stood up—sat down
—stood up again—and after a moment’s hesitation, said, “I do not
know whether I had better tell you all or nothing.”
 “Tell me all,” cried Hamilton, eagerly; “no one can feel more
interested than I do, in everything that concerns you.”
“The all is easily told,” she said, slowly—“I have no confession to
make. You were right in your supposition—it would be dreadful to
me to enter a family unwilling to receive me, for I am very proud,
and his mother’s unnecessary haughtiness—rudeness, I may say, to
us all at Seon, showed me what I might expect. It was her evident
avoidance of me that made me first aware of his intentions.”
“So,” Hamilton almost whistled, while an indefinable sensation of
actual bodily pain passed through his frame, “so after all you loved
him!”
“No,” replied Hildegarde, turning away, “but I believe I could in
time have loved him.”
“No doubt,” said Hamilton, sarcastically, “with his parents’ consent
the match would be unexceptionable, and I only wonder you did not,
on the chance, make a secret engagement with him. The old Count
is killing himself as fast as he can with cold water, and were he once
out of the way, I suppose there would be little further difficulty. It is
really a pity you were so taken by surprise, that you had not time to
think of all this!”
Hildegarde’s eyes flashed, and, in a voice almost choked by
contending emotions, she exclaimed: “I deserve this insult for
trusting you—these insidious expressions of contempt are more than
I can bear, and to prevent a repetition of them, I now release you
most willingly from your promise of last night, and request you will
in future altogether banish me and my faults from your thoughts.”
Hamilton would gladly have revoked his last speech, had it been
possible—he felt that anger and jealousy had dictated every word—
but it was too late; Hildegarde gave him no time for a recantation,
she had left the room with even more than her usual impetuosity. He
no longer attempted to deceive himself as to the nature of his
feelings towards her; it only remained for him to consider how he
should in future act. That she did not care for him was evident, and
the little advance which he had made in her good opinion and
confidence, he feared he had now lost. For a moment he thought of
a retreat to Vienna, but then the idea of flying from an incidental
and perfectly harmless flirtation was too absurd! Besides—could he
hope that chance would be again so favourable, and place him on
the same terms of intimacy with another family? It was not to be
expected; so he resolved to remain where he was—but to employ
his time differently. He would study more with Biedermann—attend
lectures at the university, ride, walk, call at the English
Ambassador’s, be presented at court, make acquaintance with the
English in Munich, and accept evening invitations. Hildegarde’s
indifference should be met with at least apparent indifference on his
part, and he would take care she should never discover the interest
which he now knew he could not help attaching to her most trifling
actions. A low murmuring of suppressed voices from the adjoining
room, which he had indistinctly heard, at length ceased altogether,
leaving nothing but footsteps of an occasional passenger through
the solitary street to break the silence of the night. He felt irritated
and impatient, and, hoping that a walk by moonlight might have a
tranquillising effect, he turned quickly from the window. Great was
his astonishment on discovering Crescenz standing beside him—
tears stood in her eyes, as she laid her hand on his arm to detain
him, and said in a scarcely audible voice, “I must ask you a question
—will you answer me?”
“Certainly,” replied Hamilton, much surprised.
“Did you tell Major Stultz this evening that you had never admired
—never liked me?”
“No—I rather think I said I admired both you and your sister
exceedingly.”
“I know you did,” cried Crescenz, “I heard what you said, and
remember it perfectly—and now he—he wants to persuade me that I
am mistaken, and assures me you greatly prefer Hildegarde, and
that you said so to him most explicitly this evening!”
 “Must I then account for every idle word!” cried Hamilton,
impatiently. “Surely it ought to be a matter of indifference to you
what I said!”
“Hush—do not speak so loud—he is there.”
“Who?”
“Major Stultz. He is waiting for me. I have such reliance on you,
that I have told him I cannot believe what he has said. And now
answer my question quickly. Have you ceased to care for me? and
do you prefer Hildegarde?”
“Pshaw,” cried Hamilton, taking up his hat, and endeavouring to
conceal his embarrassment, “I like you both and admire you both;
but when Major Stultz was jealous this evening, I gave, of course,
the preference to Hildegarde.”
“Is this the very truth?” asked Crescenz.
Her manner was unusually serious, but Hamilton was not in the
habit of paying much attention to anything she said, and answered
with a careless laugh, “What importance you attach to such a trifle!”
“If you can laugh, I have indeed mistaken you!”
“What do you mean?” asked Hamilton, exceedingly bored.
“At the beginning of our acquaintance,” said Crescenz, almost
whispering, “Hildegarde said you were amusing yourself at my
expense; this I am sure was not the case; but Major Stultz not only
says that you never cared for me, but insists that you have openly
acknowledged a preference for Hildegarde.”
“And if this were true?” said Hamilton, twirling his hat on the end
of his cane.
“If it be—I—can—never trust any man again!”
“A most excellent general rule, at all events; we are in fact not
worthy of trust, and your sister says I am not better than others,
you know!”
 “Is this your answer?” asked Crescenz.
“If you will consider it one I shall be infinitely obliged to you, for I
am really at a loss what to say.”
“It is enough,” she said, turning away.
“Stay!” cried Hamilton, perceiving at length that something
unusual had occurred. “Stay—and tell me quickly what is the matter.
What have you been saying to Major Stultz?”
“He accused me of liking some—other—better than I liked him—
and I did not deny it; he named you—and—and——”
“I understand,” said Hamilton, quickly; “and he told you that you
were slighted. Come, I will explain everything to him satisfactorily.”
They entered the next room, but Major Stultz was no longer there.
“He has gone to mamma!” cried Crescenz, clasping her hands, and
then sitting down, she added, with a sort of desperate resignation, “I
don’t care what happens now!”
“But I do,” cried Hamilton. “I will not be the cause, however
innocent, of separating you and Major Stultz. I see I must go to him
this moment and take the whole blame on myself; if you afterwards
refuse to fulfil your engagement with him, that is your affair. This
must, however, be the very last time we ever speak on this subject.
It seems I must pay dearly for my thoughtlessness; but it will be a
lesson which I am not likely to forget as long as I live.”
At one of the windows of the corridor Madame Rosenberg and
Hildegarde were standing—the former was speaking loudly and
angrily. “I never knew anything so absurd as Crescenz’s conduct! To
choose Mr. Hamilton of all people in the world for the object of a
sentimental love! If she had not been a simpleton, she might have
easily perceived that he thinks of everything rather than of such
nonsense. As to what the Major hinted about his having said that he
liked you, that was said at my particular request; so don’t you begin
to have fancies like Crescenz.”
 “There is not the slightest danger,” said Hildegarde, with a scornful
smile.
“Where is Major Stultz?” said Hamilton, hastily opening the hall-
door.
“He is gone home, I am sorry to say. Oh, Mr. Hamilton, this is a
most unpleasant business! If Crescenz’s marriage should be broken
off now, it will be an actual disgrace.”
“It will not be broken off. I can explain everything.”
“Let me give you a hint what to say,” cried Madame Rosenberg,
detaining him, “for he is exceedingly angry, and says we have all
been deceiving him. Can you not just set matters right—say that you
have paid Crescenz some attentions, and that you did admire her
some time ago!”
“Of course I shall say that,” replied Hamilton, endeavouring to get
away.
“Say, too, that she does not really care at all for you, and was only
trying to make him jealous this evening because he called her a
coquette. And then, to frighten him, you may as well add that you
will renew your addresses to-morrow if he do not at once make up
his quarrel with her.”
“I shall tell him the truth and blame myself—even more than I
deserve,” said Hamilton, closing the door and running down stairs.
“He certainly is an excellent young man!” exclaimed Madame
Rosenberg, “and notwithstanding his youth, I see I may transfer the
arrangement of this disagreeable affair to him. At all events, I can
do nothing more to-night, and may as well go to bed. Tell Crescenz I
do not wish to see her until to-morrow. What is said cannot be
unsaid, and scolding now would be useless. What will your father
say when he hears what she has done?”
Hamilton was longer absent than he had expected. He had
overtaken Major Stultz just as he was about to enter his lodgings,
had walked up and down the street with him more than an hour in
earnest conversation, and had afterwards accompanied him to his
rooms. It was past midnight as he quietly entered the house by
means of the latch-key given him by Madame Rosenberg, whose
voice he heard calling him the moment he had opened the door, and
immediately after, her husband, in a long flowered cotton dressing-
gown and slippers, appeared and invited him to enter their room.
Hamilton hesitated; but on being again called by Madame Rosenberg
he courageously advanced. A few oblique rays of moonlight and a
dimly-burning night-lamp contended for the honour of lighting the
apartment and showing Hamilton a chair near Madame Rosenberg’s
bed, which she requested him to occupy while he related
circumstantially where he had overtaken Major Stultz, what he had
said to him, what Major Stultz had answered, and what chance there
was of his forgiving and forgetting Crescenz’s sentimental
confession. Hamilton related as much as he thought necessary, and
then said he was the bearer of a letter.
“A letter! give it to me; that will explain all,” cried Madame
Rosenberg.
“It is for—for Mademoiselle Crescenz,” said Hamilton, hesitating.
“No matter; on such an occasion parents have a right to make
themselves acquainted with the true state of the case; besides, I
don’t quite trust Crescenz just now, although her father, for the first
time in his life, has lectured her severely while you were absent.
Franz, light the taper, and let me see what the Major has written.”
Hamilton most unwillingly gave up the unsealed letter committed
to his charge, and watched Madame Rosenberg with some irritation,
as she, with evident pleasure, perused it. A more extraordinary
night-dress he had never seen than that on which the light of the
taper now fell; he was, as may be remembered from his remarks at
Seon, rather fastidious on the subject of nightcaps. Madame
Rosenberg’s was interesting from the peculiarity of its form,
resembling a paper cornet, the open part next her face being
ornamented by a sort of flounce of broad lace, and the whole kept
on her head by a foulard kerchief tied under her chin. She wore a
jacket of red printed calico, of what she would herself have called a
Turkish pattern, the sleeves of which were enormously ample at the
shoulders, proving that the fabrication was not of recent date. Her
husband held the taper, looked over her shoulder, and seemed
exceedingly pleased with the contents of the letter, which Madame
Rosenberg returned to Hamilton, saying, “I perceive you have very
nearly said what I recommended, and we are very much obliged to
you. It really would have been a most unpleasant business had this
marriage been broken off, and the Major more than hinted he would
do so.”
“You are detaining Mr. Hamilton, my dear Babette,” observed Mr.
Rosenberg, mildly.
She laughed—pulled and thumped her pillows, and again wished
him good-night.
Hamilton found the door of Crescenz’s room open, she and her
sister had evidently expected him—they were seated at the window,
and either for the purpose of enjoying the moonlight, or as Hamilton
afterwards supposed, to make their features less distinct, they had
extinguished their candle. Hildegarde pushed back her chair,
Crescenz hung her head at his approach. “I have brought you a
letter,” he said to the latter, “which I hope will give you pleasure.
Major Stultz will be here early to-morrow, and trusts in the
meantime you will try to forget all that has passed between you this
evening. He sees that his absurd jealousy was enough to provoke
you to say all, and more too, than you have said to him, and he is
ready to believe that you spoke under the influence of extreme
irritation. In short, he is sincerely attached to you, and it will be your
fault if a perfect reconciliation do not take place to-morrow.”
“I suppose he must have been very angry,” said Crescenz, in a low
voice, while she twisted the letter round in her fingers. “I suppose
he must have been very angry, as you remained out so long.”
“Yes, at first; but then I told him he had no right to be angry with
you because you happened to be loved by others.”
 “Indeed! Did you say that?” cried Crescenz.
“That is,” said Hildegarde, with a slight sneer, “you have said
exactly what mamma recommended.”
Hamilton felt extremely angry, but resolved not to let Hildegarde
perceive it. He answered calmly, though a slight frown contracted his
eyebrows: “No, mademoiselle—not exactly—for I said only what was
the truth.” While he spoke, as if to brave her, he seated himself
deliberately on the chair beside Crescenz, and took her hand, while
he added: “I told Major Stultz how much I admired you, how
thoroughly gentle and forgiving you were; but I explained to him
also, without reserve, my own position in the world, and all the
miseries entailed on a younger son in England.” Hamilton here
explained at some length the difference between the equal division
of property among children so general in Germany, and the
apparently unjust privileges of primogeniture in England; dwelt long
and feelingly on the struggles and vexations of a younger son
brought up in luxury, and then cast with all his expensive habits in
comparative poverty on the world; the necessity of pushing himself
forward by his talents; the impossibility of an early marriage! He
spoke long and eloquently, and made an evident impression on both
his hearers. Crescenz’s tears fell fast on the letter, which she had
unconsciously crumpled in her hand, without having thought it
worthy of perusal. Hildegarde leaned on a small work-table, her eyes
fixed intently on Hamilton, her lips apart, and an expression of
strong interest pervading her whole form; she followed him with her
eyes, but remained immovable as he rose to leave them, and
watched with what Hamilton thought a look of subdued anger, while
he pressed Crescenz’s hands in both his, whispering his wishes for
her happiness, and his hopes that she would not misunderstand him
in future.
 CHAPTER XVIII.

THE CHURCHYARD.

Hamilton experienced a sort of satisfaction in avoiding both sisters

for some time—the idea that he was endeavouring to cure Crescenz
of her too evident partiality was almost sublime, and would probably
have turned his youthful head had not Hildegarde formed a
counterpoise. Her former dislike to him seemed to have returned
with redoubled force. She scarcely looked at, never spoke to him,
and seemed not in the least to observe that he no longer passed the
evenings at home. He had found no difficulty in disposing of his
time; introductions to a few German families had been followed by
general invitations, of which he availed himself at first with eager
pleasure, but soon afterwards with a feeling of indescribable ennui;
he missed Hildegarde’s society, and began to consider in what way
he could imperceptibly renew their former intimacy; but this was
more difficult than he had imagined, for the sisters seemed to have
formed an alliance offensive and defensive against him. Crescenz no
longer sang when learning to make pies and puddings in the
kitchen; and if he looked in, she retreated behind the dresser.
Hildegarde’s door was now always shut, perhaps because the
weather had become colder, but Hamilton imagined it was to prevent
his leaning against the door-posts, to watch her giving her brothers
instruction until the dinner was announced. The rarity and shortness
of his present intercourse served but to keep her in his memory, and
perpetually renew his regret for their last most unnecessary quarrel.
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