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EPS: What to look for? - Views on News from Equitymaster
 
 
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  • Jan 19, 2009

    EPS: What to look for?

    The earning season is now well and truly upon us. In the coming few days, the media, analysts and investors will obsess about the numbers reported for the period and the expectations for the coming quarters. It is perhaps a good time to examine what Benjamin Graham had to say about ‘earnings record’.

    The earnings record checklist

    1. Qualitative factors: Numbers make sense only when viewed in context. The qualitative characteristics of the business provide the context. The nature of the business determines how useful the past record can be as an indicator of future.

    2. Latest earnings: The market tends to overreact to the latest earnings figures. It tends to project the current situation into the future. Although, in some cases companies change dramatically, more often than not, a sudden rise or decline in earnings tends to returns to normal over time. Hence, the investor should give disproportionate importance to latest earnings only when he’s convinced that the underlying qualitative characteristics of the business have changed decisively.

    3. The long term track record: One must look at the record over many years for 2 reasons. Firstly, a consistent performance deserves more credit and secondly, a long term average evens out the impact of business cycles.

    4. Stability: In considering past averages, a stable record which stays close to a central figure deserves more credit than a mixture of unconnected numbers.

    5. Growth rate: The market tends to give a lot of importance to trends or growth rates as opposed to average numbers. The investor must enquire into the reasons for a strong trend and think about the factors in favour of and against continued growth.

    6. P/E multiple: While a company with excellent growth prospects deserves a good multiple in arriving at the stock price, it should be within limits. Although, many conditions determine the multiple- the most important being interest rates on long term bonds, a number beyond a certain number, say 20X, proves to be dangerous.

     

     

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