Security Analysis by Benjamin Graham and David Dodd was first published in 1934. It is a fundamental book for serious students of value investing.
In recent times, emphasis has been shifted from the balance sheet to income accounts, however, the authors think income accounts can't be properly understood without understanding the balance sheet of a company.
For an income statement to be worthwhile, an analyst should adjust for nonrecurring items, consider subsidiary operations and analyze the reserve activities of the company. The authors, through various examples, prove that nonrecurring items distort true earning power. In the case of financial companies, special emphasis should be taken care of analyzing the income account.
In the area of reserves, the writers discuss the use of inventory reserves that could complicate the analysis, even among companies within the same industry. So, appropriate care should be taken.
Apart from the above, an analyst should exclude nonoperating expenses to estimate true earning power. Lastly, the authors discuss the appropriate use of capitalized charges through various examples.
In the case, where the company has unconsolidated subsidiaries, the authors suggest including the equity interest of the undivided profit and loss to the parent company earnings. This decision shouldn't be based on some rules but rather on how material is subsidiary's contribution. However, an analyst should be careful about deceptive practices used by management to inflate earnings.
When a subsidiary incurs losses careful treatment should be given to understand whether those are temporary.
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