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Essential Takeaways From Chapter 12 of The Intelligent Investor: Things to Consider About Per-Share Earnings

Chapter 12 of "The Intelligent Investor" by Benjamin Graham focuses on per-share earnings and what investors should consider when evaluating this metric.

What Per-Share Earnings Mean

Per-share earnings is a company's net income divided by the number of outstanding shares. This metric can be useful for evaluating a company's profitability and growth potential, but it is important to consider other factors as well.

The Importance of Comparing Per-Share Earnings

Graham emphasizes that it is important to compare per-share earnings across different time periods and with other companies in the same industry. This is because changes in the number of shares outstanding can significantly impact per-share earnings.

For example, if a company issues more shares, its per-share earnings will decrease, even if its net income remains the same.

Some industries naturally have higher or lower profit margins than others, so comparing a company's per-share earnings to other companies in the same industry is important.

The Pitfalls of Focusing Solely on Per-Share Earnings

Graham also warns against focusing solely on per-share earnings as a measure of a company's success. For example, a company may have high per-share earnings but also carry a large amount of debt, which could indicate financial instability.

Additionally, a company may have lower per-share earnings but be investing heavily in research and development, which could lead to significant growth in the future.

Investors should also look at a company's growth potential when evaluating per-share earnings. A company that is reinvesting its earnings into research and development or expanding its operations may have lower earnings per share in the short term but may be poised for strong growth in the future.

Dilution and the Impact on Per-Share Earnings

Graham also discusses the concept of dilution, which occurs when a company issues additional shares or stock options to employees.

This can impact per-share earnings because the net income is now spread across a larger number of shares. Graham suggests using the diluted earnings-per-share metric, which takes into account the impact of dilution on per-share earnings.

Adjusting Per-Share Earnings for Inflation

Graham notes that it is important to adjust per-share earnings for inflation when comparing them across different time periods. This is because inflation can erode the value of earnings over time, making them less meaningful. By adjusting for inflation, investors can get a better sense of a company's true growth and profitability.

In addition to these considerations, investors should also look at a company's management team and overall financial health when evaluating per-share earnings. A strong management team with a track record of success and a healthy balance sheet can indicate that a company is well-positioned for long-term success, even if its per-share earnings are not currently very high.

Conclusion

Chapter 12 of "The Intelligent Investor" emphasizes the importance of understanding and comparing per-share earnings when evaluating a company's financial health. However, investors should also consider other factors, such as debt levels, research and development investments, and the impact of dilution on per-share earnings.

Additionally, it is important to adjust for inflation when comparing per-share earnings across different time periods.



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