Intelligent Investor: Things to Consider about Per-Share Earnings

Benjamin Graham, the grandfather of value investing who counts Warren Buffett among his disciples, published his book The Intelligent Investor over 70 years ago in 1949. In it, he outlines the core principles of value investing, emphasising a disciplined, long-term approach that focuses on analysing company fundamentals to minimise risk.

In chapter 12, he talks about how to approach per-share earnings, with one main piece of advice: we shouldn’t blindly trust reported earnings per share (EPS), because they can be misleading, manipulated, or misunderstood.

Graham’s earnings advice: proceed with caution

Graham gives readers two important pieces of advice related to earnings right at the outset of the chapter. He says, “This chapter will begin with two pieces of advice to the investor that cannot avoid being contradictory in their implications. The first is: Don’t take a single year’s earnings seriously. The second is: If you do pay attention to short-term earnings, look out for booby traps in the per-share figures.” In short, don’t believe everything you see!

Graham states that earnings-per-share (EPS) numbers are often misleading, easily manipulated, and should never be taken at face value, especially in the short term. And it’s not just about the numbers themselves, but about how those numbers are presented, adjusted, and interpreted.

Graham takes the example of industrial bellwether firm ALCOA (Aluminum Company of America). On the surface, ALCOA’s reported earnings made the stock look attractively priced. But a deeper look revealed multiple versions of earnings: “primary earnings,” “net income after special charges,” and “fully diluted earnings.” Depending on which figure you used, the company appeared either cheap or expensive.

For instance, focusing on optimistic quarterly numbers suggested the stock traded at around 10 times earnings—a bargain. But including special charges dropped earnings sharply, implying a valuation closer to 22 times earnings. The difference wasn’t trivial; it completely changed the investment case. Graham’s point is: there is no single “true” earnings number unless you understand what’s behind it.

What to watch out for

Graham highlights several common ways earnings can mislead investors.

• Special charges: Companies often bundle losses into one bad year and label them “non-recurring,” making future earnings look stronger. But many of these losses are simply part of normal business operations.
• Earnings manipulation via timing: Firms may shift future losses into the current year—especially during already weak periods—to “clean up” their books and boost future results.
• Dilution and hidden earnings reduction: Convertible bonds and stock warrants can increase the number of shares outstanding, reducing true earnings per share. In some cases, this can cut apparent earnings dramatically.
• Tax tricks: Past losses can be used to reduce future tax payments, artificially inflating reported profits in later years.
• Accounting methods that distort earnings: Choices like depreciation methods, inventory valuation (FIFO vs LIFO), and R&D treatment can significantly alter reported earnings without changing the underlying business.
• Overreaction to small EPS differences: Wall Street often reacts strongly to minor changes, like say, 9% growth versus 4.5%. Graham considers this irrational because a single year’s numbers rarely reflect long-term value.

What investors should look for instead?

Rather than getting caught up in short-term earnings noise, Graham suggests a more grounded and long-term approach.

• Use average earnings (7-10 years): Averaging smooths out business cycles and one-off events, giving a clearer picture of a company’s true earning power.
• Focus on proper growth: Instead of relying on recent spikes, compare multi-year averages over long periods to assess sustainable growth.
• Don’t blindly trust valuations: Strong past performance doesn’t guarantee high valuations. Markets often price in future expectations, which may differ sharply from historical trends.

To sum it all up…

Graham’s real lesson isn’t just about accounting—it’s about how investors should think.

• EPS isn’t pure fact; it depends on accounting choices and management decisions
• Companies can present earnings in ways that shape how investors perceive them
• Short-term numbers are often noisy and unreliable
• Looking at long-term averages gives a clearer picture
• Even the best valuations aren’t perfect and markets can be inconsistent

Ultimately, Graham encourages investors to stay grounded. Rather than obsessing over every reported number, focus on whether you are buying a solid business at a reasonable price – and always maintain a healthy skepticism toward what the numbers appear to say.