Booby Traps in the Per-Share Figures

Dear fellow investors,

My last issue was published late and off-cycle, as is this issue, both due to personal reasons. I am trying to get back on schedule as quickly as possible, so please bear with me. As you can probably guess by now, all I have really had time to do outside of my 9 to 5 is read. I only managed to complete chapters 12, 13, and 14 since my last issue was published, as I had to take a few days off. I am pushing to read at least one chapter and its commentary every day, and I am expecting to finish The Intelligent Investor by November 7th.

This is actually a bit later than I wanted, as a number of my investments have already reported their quarterly earnings and I’d like to make a more concerted effort to read those reports. I am struggling to find the time to develop a new skill set, build a business, and manage a portfolio, all while working a day job, not to mention the major inconvenience I’m now dealing with in my personal life. Anyway, I’d like to think that after I finish reading The Intelligent Investor, I can use the time I spent reading that book to read earnings reports and conduct research & analysis, at which point I’ll be managing my portfolio and developing the skill set of an enterprising investor simultaneously through hands-on experience. In the meantime, I have been doing my best to keep up with the headlines and skim a few articles as a way to stay somewhat informed on my holdings, but I feel like this barely scratches the surface.

Funny enough, chapter 12, titled Things to Consider About Per-Share Earnings, couldn’t have come at a better time. The chapter taught me not to “take a single year’s earnings seriously”¹, and in the event that I do “pay attention to short-term earnings,”¹ I should be on the “look out for booby traps in the per-share figures”¹. Something I hadn’t realized when looking at financial reports in the past is the difference between GAAP and non-GAAP results.

I had no idea that companies could inflate their earnings by excluding certain expenses like stock-based compensation, restructuring charges, and even research and development in their non-GAAP reports. I certainly understand why, in some instances, excluding certain one-time items might paint a more accurate picture of a business’s current state. On the other hand, I can see how a company could use non-GAAP figures to make its reports more appealing than they really are. Either way, to Jason’s credit, I now know I need to pay special attention to these figures on a quarterly and yearly basis. And to Graham’s credit, I now know I need to take these short-term earnings reports with a grain of salt.

I got the impression that calculating the average earnings over a seven- to ten-year period could provide me with “a better idea of [a] company’s earning power”¹. That’s something I’m going to want to do when measuring a company’s performance using the six dimensions Graham has mapped out in chapter 13: profitability, stability, growth, financial position, dividends, and price history, all of which, except for one, “look past the price of the stock to the performance of the business it represents”². In my opinion, this supports the idea that the value of a business is entirely separate from its stock price and should be evaluated as such, which is something I wrote about in my previous issue.

I also mentioned in my previous issue that I would use forecasting to help determine if a company has a future. In chapter 14, Graham states that “every competent analyst looks forward to the future”,³ but “the future itself can be approached in two different ways which may be called the way of prediction (or projection) and the way of protection”³. I certainly align more closely with the way of protection, as I want to “be reasonably confident that the enterprise will get along”³, which is what I previously stated I would use forecasting for. I am also “concerned with the price of the issue at the time of study”³ as I want to purchase businesses at fair prices compared to their current value in an effort to create a margin that could absorb any unfavorable future developments.

I’m not going to lie, when I read this section of chapter 14, I was impressed with myself. The fact that I had already thought about using forecasting as a way to determine if a company has a future before reading about it indicates to me that I am beginning to think like an investor. I’m going to end on that note, and hope that I have no further personal disruptions that would prevent me from reading the final few chapters by November 7th.

Thanks for reading,

Eric Seel