Written by Hurricane Blog
“…the phrase “earning power” must imply a fairly confident expectation of certain future results. It is not sufficient to know what the past earnings have averaged, or even that they disclose a definite line of growth or decline.” ―Graham & Dodd, Security Analysis (6th Ed.)
A few thoughts from Graham & Dodd and Marty Whitman about how to think about earnings and how it may differ from earning power.
In The Aggressive Conservative Investor Marty Whitman discusses the importance and implications of distinguishing between earnings and earning power:
Given the varied economic definitions of earnings, it may be wise to distinguish between earnings and earning power. By “earnings” is meant only reported accounting earnings. On the other hand, in referring to “earning power” the stress is on wealth creation. There is no need to equate a past earnings record with earning power. There is no a priori reason to view accounting earnings as the best indicator of earning power. Among other things, the amount of resources in the business at a given moment may be as good or a better indicator of earning power.
Graham & Dodd also put down their thoughts about earning power, for instance in Security Analysis (quotation below from the sixth edition) in which they wrote:
