CHAPTER 3
Valuation Based on Earnings (Income)
A penny saved is a penny earned.
—Benjamin Franklin, Poor Richard’s Almanac
EARNINGS—THE DIFFERENCE between revenues and expenses during a specific period—provide an important clue to the investment value of a company. As noted in a foundational U.S. accounting pronouncement, earnings are “the basic source of compensation to owners for providing equity or risk capital to an enterprise.”1
As mentioned in Chapter 1, corporate leaders tend to favor earnings as a measure for corporate performance, while shareholders tend to favor cash flow, since it seems more closely related to returns to shareholders.2
But although the relationship between earnings and returns to shareholders is not always easy to ...
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