Earnings Power vs. Asset Value - Graham's Lens

Graham's emphasis

"The value of a common stock depends primarily on the company's earning power and assets." - The Intelligent Investor, Ch. 11
"Stocks selling below liquidation value are in most instances worth considerably more than their market price." - Security Analysis, Net-Current-Asset Stocks

Graham flexes between two anchors: earnings power for steady businesses, asset value for distressed or overlooked balance sheets.

When to favor asset value

• Earnings are depressed or erratic.
• Tangible current assets clearly exceed all liabilities.
• Inventories and receivables can be haircut to realizable levels.
• Catalysts exist (asset sales, liquidations, buybacks).

When to favor earnings power

• Long, stable record of profits and dividends.
• Business model is understandable and durable.
• Normalized earnings can be estimated without heroic assumptions.
• Balance sheet supports the earnings (no fragile leverage).

How to compute each

• Asset value (NCAV): Cash (100%) + receivables (70-90%) + inventory (0-50%) - total liabilities.
• Earnings power: Normalize over a full cycle, haircut outliers, apply a cautious multiple, and demand a discount to that value.

Blending for safety

• Take the lower of asset value and earnings-based value as your base.
• Demand a margin of safety to that lower number.
• Size positions based on which anchor is firmer and how far price sits below it.

Takeaways

• Pick the anchor the business justifies: assets for balance-sheet bargains; earnings for durable, steady firms.
• Haircut aggressively; assume you are roughly right, not precisely right.
• Use the lower value and add a margin of safety before you act.