138 ShowMetheMoney
A neophyte investor’s mistake, in any event, is to assess business
value solely on the basis of the balance sheet, even after overcoming
the limits impose dby accounting principles. Unless you are in dee d
valuing a company for purposes of liquidating it, what you really
want to know is not what its assets coul dsell for but what earnings
an dcash they spin off.
Graham recognize dthe limits of a balance sheet. Noting that it
is quite useful with respect to working capital position, Graham cau-
tione dthat it is of less use concerning the carrying amount of fixe d
assets, which he sai d“must not be taken too seriously,” an dthe
figure at which intangible assets are listed, to which he said “little
if any weight shoul dbe given.”^7 He advised:
It is true that in many individual cases we find companies with
small asset values earning large profits, while others with large
asset values earn little or nothing. Yet in these cases some at-
tention must be given to the book value situation, for there is
always a possibility that large earnings on the investe dcapital
may attract competition an dthus prove temporary; also that
large assets, not now earning profits, may later be made more
productive.^8Accordingly, Graham concluded that “book value is of some im-
portance in analysis because a very rough relationship tends to exist
between the amount investe din a business an dits average earnings,”
where the real money is.^9
EARNINGS
Earnings refer to accounting earnings as reporte don the “bottom
line” of an income statement. These figures are separate dinto basic
earnings per share an d dilute dearnings per share. Basic earnings
per share are the total earnings divided by the average number of
common shares outstanding during the period.
Dilute dearnings take account of the possibility that some con-
vertible securities an dstock options coul dincrease the number of
common shares outstanding. This reduces the earnings per share by
taking into account the conversion or exercise of those instruments.
Focus on the dilute dearnings per share (an dbear in min dthat even
that figure does not always reflect full dilution or cost of stock op-
tions issue dto managers, as we will see later).