value
Normalise the earnings
The rule
Judge a company's real earning power on many years' average, not one year. One good year can fool you; one bad year can scare you.
Where it flips
But averaging can hide a real, lasting change by mixing it with old years. The fix is to average first, then ask if a true change should push your guess a little up or down.
One year's profit is like a photo taken in changing light. A boom year makes it look great. A weak year makes it look scary. And one-time gains or losses mislead you. So average the profit over several years, ideally a full up-and-down cycle. That steady number shows the real earning power. A fair price should rest on that, not on one lucky year.
A worked example
An up-and-down company earns ₹5, then ₹9, then ₹14, then loses ₹2 over four years. Pricing it on the ₹14 peak looks cheap but is a trap. The roughly ₹6.5 average is the honest base to value it. [illustrative]
How to spot it
- ·a price resting on one big year
- ·the best or worst year treated as normal
- ·one-time items not removed
Benjamin Graham · The Intelligent Investor