If you’re a value investor you probably use some sort of average of a company’s earnings history (7 or 10 years for example) to come up with an initial number for the company’s normal earning power in any given year.
If you use the company’s reported earnings figures to derive your average and want to check the accuracy of these numbers try this: calculate the total change in common equity over the time period in question, add all dividends paid to common stock holders and then derive a per share number for how much a company earned (be careful not to count capital raises and/or goodwill generated by acquisitions towards operating earnings).
I call this number “balance-sheet earnings.”
Much to my surprise it often doesn’t match a company’s reported earnings numbers over the same time period.
So which one should you go with?
If you or I owned the entire company the only value we would get as private owners is:
- Growth in the company’s common equity; and
- Dividends paid to common shares.
The same logic applies to stocks you purchase on the open market.
So before you discount a normalized earnings figure based on a company’s reported earnings to calculate intrinsic value check the balance sheet earnings for the period in question.
If they match great.
If they don’t I normally stick with the balance sheet earnings: if I was a private businessman and owned the entire company that is all that would matter.
For more information see Security Analysis by Benjamin Graham.
