Intelligent Investor Chapter 12 Summary: Things to consider about Per Share Earnings

Things to consider about Per Share Earnings

• 1) Don't take single year's earnings seriously. 2) If you pay attention to short term earnings, look out for booby traps in per share figures.
• Long term record and prospects should be considered, but with too much advertising of quarterly and annual results, it becomes difficult to ignore them.
• ALCOA quoted different per share earnings in it's footnotes by including dilution factor(bond/preferred stocks converted to stocks) and special charges which are actually anticipated future costs and losses. These special charges will paradoxically earn fine profits in future because of tax benefit on past losses.
• Treating depreciation as straight line when previous year's depreciation is calculated based on accelerated schedules.
• Writing off R&D costs or amortizing them over a period of time.
• Pro forma costs.
• Unrealistic expectations from pension funds which inflate earnings.
• Special purpose entities - firms/affiliates/partners that buy off risky assets/liabilities to remove them from balance sheet.
• Marketing/soft costs shown as assets rather than as normal expenses.
• Consider earning power on the basis of full income tax liability.
• Average earnings over 7-10 years is better than EPS as special charges and credits are all included. Use this with ratings for growth and stability of earnings to know actual performance.
• Compare growth rate for last 3 years on average with ten years earlier.
• High multipliers arise for companies that maintained better than average profitability. Market isn't kind to growth companies but to these in depression.

Commentary:

You get ripped off easier by a dude with a pen than you can by a dude with a gun.

• Pro forma: Original idea was to provide a true picture of long term earnings smoothing out any non recurring events. But this is greatly abused. Ignore this.
• Qwest has shown monthly installment earnings as a whole pumping up it's net income by 240 million.
• Global Crossing Ltd showed optical fibers laid as capital expenditure instead of operating expenses.
• Micron has slashed it's inventory prices and written it off as non recurring cost.
• SBC set aside pension fund whose returns were overestimated as excess and treated it as current income.
• Check if net pension benefit < 5%* (net income).
• Read statements from the last page.
• Read footnotes however technical and obscure they can be - how company recognizes revenue, records inventories, treats installment/contract sales, expenses its marketing costs and disclosures about debt, stock options, loans to customers, reserves against losses and other risk factors.
• Enterprising investor should learn about financial reporting. Financial statement analysis, The financial numbers game, Financial shenanigans are good books.

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