It's Earning That Count- Finding Stocks with Earnings Power for Long-Term Profits

It’s Earning That Count- Finding Stocks with Earnings Power for Long-Term Profits

By Hewitt Heiserman Jr.

This book shows you how to look beyond reported figures to find those needle-in-the haystack companies that will power your portfolio with profits and growth proven to last for the life of the portfolio. This book is written keeping in mind needs of long term investor. Some one who is interested in finding and investing in great growth stocks, The Author presents a investing framework that helps you find grate growth stocks for next decade and more.

Heiserman proposes two step methodology.

Step 1 is to validate sating power of the business. He calls it defensive income statement. Whether the company can self fund its growth or needs to depend on external funding to propel its growth. The holy grail of any business is to earn so much that you can fund the growth using internal accruals and still have enough left for owners. Defensive income statement tells us if there is even a remote risk of possible indebtedness (then distress) or equity dilution in order to fuel the growth.

Step 2 is to validate value added by the earnings growth. He calls this enterprising income statement. Here the author subjects the reported earnings to the true cost of shareholder funds. We often take the cost of equity for granted and assume it is free. This is especially pernicious problem among DCF fans. In his framework Heiserman asks us to subtract the cost of equity form the reported earnings to get the real earning power of the firm. That is the one you use for your analysis.

The serious students of investing will recognize that the step 1 is close to free cash flow or owner’s earnings as alluded by Buffet. While step 2 is EVA or residual earnings concept. Heiserman’s value addition is to present step by step recipe to prepare these 2 reformulated or adjusted income statements for analysis. His other value add is 4 quadrant Earning power chart where you plot defensive and enterprising profits on Y and X axis respectively. He asks us to plot the progress of the company year after year (or past years) and see how it is/has been progressing. You can see the positive progress as well as deterioration easily on this earning power chart. Hopefully this will help the investor detect impending disaster ahead of time.

He also discusses management quality and valuation. Both are excellent and to the point. I especially enjoyed very simple and commonsense approach used by Heiserman to value protagonist stock (Wrigley) in this book. He shows that investing can be simple if not easy.

Overall this is useful book for intermediate investors who are not afraid of playing with financial statements. If you think you can readjust income statement a bit and do few computations to get some numbers then his method can help you find high quality growth firms. The firms that Warren Buffet would love to buy. Just make sure you don’t overpay.

I have no hesitation recommending this good book to Valuepickr community.

Point for debate:

Which companies you can think of that meet this dual criteria- safe and value accretive growth?

Some examples I can think of- Colgate, Cummins, ITC, HUL, Atul Auto? and many more…

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Hi Girish,

This book is on my reading list for a long time since it was also recommended by Prof. Sanjay Bakshi. Hopefully, I would be able to read it soon.

Regards,

Ankit

@giridesh3 Thanks to a reader we were able to make a tool that automatically plots the earnings power graph
I am now considering providing the earnings power data on monthly basis by iterating this tool over all BSE stocks. Before that it would help if you could have a look at it. Ps this is a non-profit operation.

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Update: Here are 50 stocks with an excellent earnings power track record. These companies have the potential to self-fund and create value. This excellent compilation has been put together by @Lukeloki (twitter handle)

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Update: MorningStar had changed its site layout a few months and the sheet had stopped functioning. This has now been accounted for. The new sheet is here: Download free stock analysis spreadsheet & value stocks in multiple ways!

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