[1940] Ch. 37 SIGNIFICANCE OF THE EARNINGS RECORD
Edited: 1 year ago

Summary:

This chapter underlines the role of a company's earnings record in security analysis, acknowledging its limitations. While historical performance can indicate future earnings, it's not invariably reliable. The chapter introduces the concept of earning power, which blends past earnings with future expectations, given no extraordinary changes.

Earnings records should cover several years to depict consistent performance and minimize business cycle effects. The author distinguishes between average earnings and unrelated figures, emphasizing the need for qualitative alongside quantitative analysis. The permanence of a company's earning power is key to assess its stability.

The chapter also warns against solely using current earnings for valuation, given their vulnerability to short-term fluctuations, which may lead to irrational market valuations. A proposed strategy suggests buying low during earnings downturns and selling high during periods of prosperity.

The article stresses the importance of understanding a company's earnings power and trend for investment valuation, emphasizing the need for qualitative analysis. The stock market often overvalues stocks based on expected rather than actual results. When a company's earnings trend is downward, a comprehensive qualitative study can uncover potential value despite declining trends.

The analyst should also consider underlying factors like competition and regulation that can impact earning trends. Deficits should be viewed qualitatively, not quantitatively, in determining future prospects. The evaluation should mirror that of a pragmatic business person, factoring in both positive and negative elements influencing future earnings.

The article encourages a thorough analysis, distinguishing intuition from sound reasoning, and considering both current earnings and long-term trends. The author champions the reasoning that expects a company to continue as usual, offering a conservative approach. Yet, it notes that this may not apply to industries susceptible to changes and competition, and past prosperity may not always continue.

In summary, while a company's earnings record is valuable in securities analysis, its limitations and the need for qualitative considerations are emphasized.