YouMaketheCall 139In assessing what the enterprise can do for you in the future,
you only have present an dpast earnings available. How can present
an dpast earnings gui de an assessment of future earnings? Or which
of various prior year earnings or which combination is the “right”
level of earnings?
In GE’s case, four recent annual diluted earnings per share were
$2.16, $2.46, $2.80, an d$3.22; in Amazon.com’s, negative $.06,
.$24, $.84, an d$2.18 per share.
Perhaps you shoul duse only the most recent perio d. But what
if, as with GE an dAmazon.com, there is significant change in that
year compare dto the prior years? One issue is, of course, why that
change occurred. Was it due to extraordinary factors that are unlikely
to recur?
If that is the case, using the prior periods might seem appropri-
ate, though a more precise gauge for companies that periodically
experience such extraordinary occurrences is to lengthen the period
to seven to ten years to iron out those bumps. Alternatively, perhaps
the business is experiencing a steady positive or negative trend in its
earnings. In these cases, averaging the earnings over the last four
years makes sense. In GE’s case, that is about $2.66 (in Ama-
zon.com’s, negative $.83).
All these issues obviously entail judgment, and on top of that
you must recognize that the estimate is about future earnings. Tak-
ing the average earnings over the past four years an dprojecting them
forwar dto the next four years requires a further forecast of the earn-
ings growth in the future period. Despite steadily rising losses, Am-
azon.com’s management expects profits within a few years (as
apparently do thousands of its stockholders, who at one point in the
early 2000s drove its market capitalization to over ten times the
combine dtotals of its profit-making archrivals Bor ders an dBarnes
& Noble!).
GE’s earnings growth rate was about 12 to 15% in the late 1990s.
You might cautiously expect similar or slightly slower growth in the
early 2000s. Taking a conservative view of the future coul djustify a
10% growth rate—roughly $3.50, $3.90, $4.30, an d$4.75, or an
average of about $4.10.
In estimating earnings, note again the limits of accounting rec-
ords. Accounting earnings result from subtracting cash expenses
plus noncash expenses such as depreciation an dba d debt reserves
from gross revenue. This sounds simple, but the exercise entails
making a number of decisions about how various events are ac-