Q&A: The Intelligent Investor – Chapter 12: Things to Consider About Per-Share Earnings

The Intelligent InvestorBelow are my reflections and answers to the discussion questions posted at Modern Graham for chapter 12 – Things to Consider About Per-Share Earnings – of the Intelligent Investor written by Benjamin Graham.

1. What quote from this chapter do you think best summarizes the point Graham is making?

“In former times analysts and investors paid considerable attention to the average earnings over a fairly long period in the past—usually from seven to ten years. This “mean figure” was useful for ironing out the frequent ups and downs of the business cycle, and it was thought to give a better idea of the company’s earning power than the results of the latest year alone. One important advantage of such an averaging process is that it will solve the problem of what to do about nearly all the special charges and credits. They should be included in the average earnings. For certainly most of these losses and gains represent a part of the company’s operating history.”

2. How often do you read a company’s annual report to get a more realistic picture?

Pretty often, almost always at least for companies I deem as potential future investments.

3. What resources do you find helpful with analyzing how companies calculate their own earnings?

Annual reports and accounting principles in the notes to the financial statements. Also use to take a look at how different non-GAAP key ratios are calculated to make sure I understand and to be able to make a judgement about whether it makes sense or not.

4. What did you think of the chapter overall?

Except for the walkthrough of the Alcoa earnings for fiscal years 1970 and 1969 in search for the “true earnings”, I especially appreciated Graham’s discussion about the use of average earnings and calculation of the past growth rates.

Also like Graham’s skepticism when puts up a red flag by stating the first rule “Don’t take a single year’s earnings seriously.”

  • Use of Average Earnings

“In former times analysts and investors paid considerable attention to the average earnings over a fairly long period in the past—usually from seven to ten years. This “mean figure”* was useful for ironing out the frequent ups and downs of the business cycle, and it was thought to give a better idea of the company’s earning power than the results of the latest year alone. One important advantage of such an averaging process is that it will solve the problem of what to do about nearly all the special charges and credits. They should be included in the average earnings. For certainly most of these losses and gains represent a part of the company’s operating history. […] If such figures are used in conjunction with ratings for growth and stability of earnings during the same period, they could give a really informing picture of the company’s past performance.”

  • Calculation of the Past Growth Rate

“It is of prime importance that the growth factor in a company’s record be taken adequately into account. Where the growth has been large the recent earnings will be well above the seven- or ten year average, and analysts may deem these long-term figures irrelevant. This need not be the case. The earnings can be given in terms both of the average and the latest figure. We suggest that the growth rate itself be calculated by comparing the average of the last three years with corresponding figures ten years earlier. (Where there is a problem of “special charges or credits” it may be dealt with on some compromise basis.)”

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