Intelligent Investor Ch.12 - Per-Share Earnings

Things to Consider About Per-Share Earnings

Directly at the start of the eleventh chapter two very important lessons are made:

1. Don't take a single year's earning seriously
2. If you do, pay attention to short-term earnings, look out for booby traps in the per-share earnings

If you follow the first advice, normally the second advice is not needed - even though Wall Street pays great attention to the current earnings - and that is your chance!

To be sure and avoid any surprises, the annual earnings figures of a company, need to be examined thoroughly, and you should find a lot of clues in the footnotes of a 10-k!  It can be everything from special charges, future tax savings, future reserves, or dilution of shares which will affect the per-share earnings. You need to adjust for these reservations and find the true earnings - or you find the average earnings.

Use of Average Earnings

Analysts and Investors paid before more time to the average earnings of the past, normally seven to ten years!

The "mean" or "average" figure, as referred to the arithmetic mean, is taken to flatten out frequent ups and downs of the business cycle and should give a better idea of the company's earning power. This "averaging" of 10 years past earnings data will average out any special charges in a specific year. Together with the ratings for growth and stability in earnings, it gives a good view of the company's past performance.

Calculation of the Past Growth Rate

When looking at the (earnings) growth rate, it is favorable to look at both the average but as well as the latest figures. Suggested is to compare a current 3 year period (average) with an earlier 3 year period (average), e.g. average earnings 2017-2019 compared to average earnings 2007-2009.

This growth rate can further be discussed, compared with the competition, or used in relation to the price-earning ratio assumptions - remember, it is still a picture of the past!

Another point that Graham makes here is regarding companies with high multipliers (high P/E's), is that they normally have and maintain high "earnings on capital funds" which is net income divided by tangible net assets, or as we would say today as Return on Capital!

So from the last post here, we start with the Two-Part Appraisal Process and its past-performance value! 

So as an example is that you get a 10-year average EPS of $2.0 with a Growth Rate of 2.0 percent!

 - Compare it with the latest current EPS (higher or lower?), current P/E (compared to P/E with the 10-year average earnings P/E) to get a first feeling of how the company is priced at the moment compared to the calculated "Value" and past-performance!