Sunday, 5 February 2012

Inherent Permanence of Earning Power - The Income that Keeps Coming In

If past earnings are to have any meaning to investors, there must be an inherent permanence to the earning power.  

Earnings may be cyclical, or even inconsistent, and still have some permanence.

  • Many automobile companies have notoriously cyclical results; yet they have managed to keep up an ongoing business over many years.

Benjamin Graham considered a company to have stable earnings when:
  1. earnings doubled in the most recent 10 years, and,
  2. earnings declined by no more than 5% no more than twice in the past 10 years.
Another approach to measuring stability is to compare one period of earnings with an earlier period.  
  • Stability is assessed by the trend of per-share earnings over a ten-year period, compared to the average of the most recent three years.  
  • No decline represents 100% stability.
For example:  Company A earnings per share nearly doubled in the 10-year period 1984 -1994:
  • 5.22  (1984); 6.25; 6.31;.5.90; 5.08; 1.36; 0.30; -2.7, 1.38, 6.77; and 10.1 (1994)
  • 10-year average = $4.95
  • 3-year average = $6.08
  • 1994 book value = $46.65 per share
  • 1995 trading range = $38.25 to $58.13 per share

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