mal operating expenses into capital assets. As the Global Crossing
case shows, the intelligent investor should be sure to understand
what, and why, a company capitalizes.
AN INVENTORY STORY
Like many makers of semiconductor chips, Micron Technology, Inc.
suffered a drop in sales after 2000. In fact, Micron was hit so hard by
the plunge in demand that it had to start writing down the value of its
inventories—since customers clearly did not want them at the prices
Micron had been asking. In the quarter ended May 2001, Micron
slashed the recorded value of its inventories by $261 million. Most
investors interpreted the write-down not as a normal or recurring cost
of operations, but as an unusual event.
But look what happened after that:
326 Commentary on Chapter 12
A Block of the Old Chips
261.1
465.8
172.8
3.8
25.9
173.6
90.8
0
50
100
150
200
250
300
350
400

450
500
May 2001 August 2001 November 2001 February 2002 May 2002 August 2002 November 2002
Micron Technology fiscal quarters
Inventory write-downs ($ millions)
Source: Micron Technology’s financial reports.
FIGURE 12-1
Micron booked further inventory write-downs in every one of the
next six fiscal quarters. Was the devaluation of Micron’s inventory a
nonrecurring event, or had it become a chronic condition? Reason-
able minds can differ on this particular case, but one thing is clear:
The intelligent investor must always be on guard for “nonrecurring”
costs that, like the Energizer bunny, just keep on going.
5
THE PENSION DIMENSION
In 2001, SBC Communications, Inc., which owns interests in Cingular
Wireless, PacTel, and Southern New England Telephone, earned $7.2
billion in net income—a stellar performance in a bad year for the
overextended telecom industry. But that gain didn’t come only from
SBC’s business. Fully $1.4 billion of it—13% of the company’s net
income—came from SBC’s pension plan.
Because SBC had more money in the pension plan than it esti-
mated was necessary to pay its employees’ future benefits, the com-
pany got to treat the difference as current income. One simple reason
for that surplus: In 2001, SBC raised the rate of return it expected to
earn on the pension plan’s investments from 8.5% to 9.5%—lowering
the amount of money it needed to set aside today.
SBC explained its rosy new expectations by noting that “for each
of the three years ended 2001, our actual 10-year return on invest-
ments exceeded 10%.” In other words, our past returns have been

high, so let’s assume that our future returns will be too. But that not
only flunked the most rudimentary tests of logic, it flew in the face of
the fact that interest rates were falling to near-record lows, depressing
the future returns on the bond portion of a pension portfolio.
The same year, in fact, Warren Buffett’s Berkshire Hathaway low-
ered the expected rate of return on its pension assets from 8.3% to
6.5%. Was SBC being realistic in assuming that its pension-fund man-
agers could significantly outperform the world’s greatest investor?
Probably not: In 2001, Berkshire Hathaway’s pension fund gained
9.8%, but SBC’s pension fund lost 6.9%.
6
Commentary on Chapter 12 327
5
I am grateful to Howard Schilit and Mark Hamel of the Center for Financial
Research and Analysis for providing this example.
6
Returns are approximated by dividing the total net value of plan assets at
the beginning of the year by “actual return on plan assets.”
Here are some quick considerations for the intelligent investor: Is
the “net pension benefit” more than 5% of the company’s net income?
(If so, would you still be comfortable with the company’s other earn-
ings if those pension gains went away in future years?) Is the
assumed “long-term rate of return on plan assets” reasonable? (As of
2003, anything above 6.5% is implausible, while a rising rate is
downright delusional.)
CAVEAT INVESTOR
A few pointers will help you avoid buying a stock that turns out to be
an accounting time bomb:
Read backwards. When you research a company’s financial
reports, start reading on the last page and slowly work your way

toward the front. Anything that the company doesn’t want you to find
is buried in the back—which is precisely why you should look there
first.
Read the notes. Never buy a stock without reading the footnotes
to the financial statements in the annual report. Usually labeled “sum-
mary of significant accounting policies,” one key note describes how
the company recognizes revenue, records inventories, treats install-
ment or contract sales, expenses its marketing costs, and accounts
for the other major aspects of its business.
7
In the other footnotes,
328 Commentary on Chapter 12
7
Do not be put off by the stupefyingly boring verbiage of accounting foot-
notes. They are designed expressly to deter normal people from actually
reading them—which is why you must persevere. A footnote to the 1996
annual report of Informix Corp., for instance, disclosed that “The Company
generally recognizes license revenue from sales of software licenses upon
delivery of the software product to a customer. However, for certain com-
puter hardware manufacturers and end-user licensees with amounts
payable within twelve months, the Company will recognize revenue at the
time the customer makes a contractual commitment for a minimum non-
refundable license fee, if such computer hardware manufacturers and end-
user licensees meet certain criteria established by the Company.” In plain
English, Informix was saying that it would credit itself for revenues on prod-
ucts even if they had not yet been resold to “end-users” (the actual cus-
tomers for Informix’s software). Amid allegations by the U.S. Securities and
watch for disclosures about debt, stock options, loans to customers,
reserves against losses, and other “risk factors” that can take a big
chomp out of earnings. Among the things that should make your

antennae twitch are technical terms like “capitalized,” “deferred,” and
“restructuring”—and plain-English words signaling that the company
has altered its accounting practices, like “began,” “change,” and “how-
ever.” None of those words mean you should not buy the stock, but all
mean that you need to investigate further. Be sure to compare the
footnotes with those in the financial statements of at least one firm
that’s a close competitor, to see how aggressive your company’s
accountants are.
Read more. If you are an enterprising investor willing to put plenty
of time and energy into your portfolio, then you owe it to yourself to
learn more about financial reporting. That’s the only way to minimize
your odds of being misled by a shifty earnings statement. Three solid
books full of timely and specific examples are Martin Fridson and Fer-
nando Alvarez’s Financial Statement Analysis, Charles Mulford and
Eugene Comiskey’s The Financial Numbers Game, and Howard
Schilit’s Financial Shenanigans.
8
Commentary on Chapter 12 329
Exchange Commission that Informix had committed accounting fraud, the
company later restated its revenues, wiping away $244 million in such
“sales.” This case is a keen reminder of the importance of reading the fine
print with a skeptical eye. I am indebted to Martin Fridson for suggesting this
example.
8
Martin Fridson and Fernando Alvarez, Financial Statement Analysis: A
Practitioner’s Guide (John Wiley & Sons, New York, 2002); Charles W. Mul-
ford and Eugene E. Comiskey, The Financial Numbers Game: Detecting
Creative Accounting Practices (John Wiley & Sons, New York, 2002);
Howard Schilit, Financial Shenanigans (McGraw-Hill, New York, 2002).
Benjamin Graham’s own book, The Interpretation of Financial Statements

(HarperBusiness, New York, 1998 reprint of 1937 edition), remains an
excellent brief introduction to the basic principles of earnings and expenses,
assets and liabilities.
CHAPTER 13
A Comparison of Four Listed Companies
In this chapter we should like to present a sample of security
analysis in operation. We have selected, more or less at random,
four companies which are found successively on the New York
Stock Exchange list. These are eltra Corp. (a merger of Electric
Autolite and Mergenthaler Linotype enterprises), Emerson Electric
Co. (a manufacturer of electric and electronic products), Emery Air
Freight (a domestic forwarder of air freight), and Emhart Corp.
(originally a maker of bottling machinery only, but now also in
builders’ hardware).* There are some broad resemblances between
the three manufacturing firms, but the differences will seem more
significant. There should be sufficient variety in the financial and
operating data to make the examination of interest.
In Table 13-1 we present a summary of what the four companies
were selling for in the market at the end of 1970, and a few figures
on their 1970 operations. We then detail certain key ratios, which
relate on the one hand to performance and on the other to price.
Comment is called for on how various aspects of the performance
pattern agree with the relative price pattern. Finally, we shall pass
the four companies in review, suggesting some comparisons and
relationships and evaluating each in terms of the requirements of a
conservative common-stock investor.
330
* Of Graham’s four examples, only Emerson Electric still exists in the same
form.
ELTRA Corp. is no longer an independent company; it merged with

Bunker Ramo Corp. in the 1970s, putting it in the business of supplying
stock quotes to brokerage firms across an early network of computers.
What remains of
ELTRA’s operations is now part of Honeywell Corp. The firm
formerly known as Emery Air Freight is now a division of CNF Inc. Emhart
Corp. was acquired by Black & Decker Corp. in 1989.
TABLE 13-1 A Comparison of Four Listed Companies
ELTRA
Emerson Electric Emery Air Freight Emhart Corp.
A. Capitalization
Price of common, Dec. 31, 1970
27
66
57
3
⁄4
32
3
⁄4
Number of shares of common
7,714,000
24,884,000
a
3,807,000
4,932,000
Market value of common
$208,300,000 $1,640,000,000 $220,000,000
$160,000,000
Bonds and preferred stock
8,000,000

42,000,000
9,200,000
Total capitalization
216,300,000 1,682,000,000
220,000,000
169,200,000
B. Income Items
Sales, 1970
$454,000,000 $657,000,000 $108,000,000
$227,000,000
Net income, 1970
20,773,000
54,600,000
5,679,000
13,551,000
Earned per share, 1970
$2.70
$2.30
$1.49
$2.75
b
Earned per share, ave., 1968–1970 2.78
2.10
1.28
2.81
Earned per share, ave., 1963–1965 1.54
1.06
.54
2.46
Earned per share, ave., 1958–1960 .54

.57
.17
1.21
Current dividend
1.20
1.16
1.00
1.20
C. Balance-sheet Items, 1970
Current assets
$205,000,000 $307,000,000
$20,400,000 $121,000,000
Current liabilities
71,000,000
72,000,000
11,800,000
34,800,000
Net assets for common stock
207,000,000
257,000,000
15,200,000
133,000,000
Book value per share
$27.05
$10.34
$3.96
$27.02
a
Assuming conversion of preferred stock.
b

After special charge of 13 cents per share.
c
Year ended Sept. 1970.
The most striking fact about the four companies is that the
current price/earnings ratios vary much more widely than their
operating performance or financial condition. Two of the enter-
prises—eltra and Emhart—were modestly priced at only 9.7
times and 12 times the average earnings for 1968–1970, as against a
similar figure of 15.5 times for the DJIA. The other two—Emerson
and Emery—showed very high multiples of 33 and 45 times such
earnings. There is bound to be some explanation of a difference
such as this, and it is found in the superior growth of the favored
companies’ profits in recent years, especially by the freight for-
warder. (But the growth figures of the other two firms were not
unsatisfactory.)
For more comprehensive treatment let us review briefly the
chief elements of performance as they appear from our figures.
332 The Intelligent Investor
TABLE 13-2 A Comparison of Four Listed
Companies (continued)
Emerson Emery Emhart
ELTRA Electric Air Freight Corp.
B. Ratios
Price/earnings, 1970 10.0 ϫ 30.0 ϫ 38.5 ϫ 11.9 ϫ
Price/earnings, 1968–1970 9.7 ϫ 33.0 ϫ 45.0 ϫ 11.7 ϫ
Price/book value 1.00 ϫ 6.37 ϫ 14.3 ϫ 1.22 ϫ
Net/sales, 1970 4.6 % 8.5 % 5.4 % 5.7 %
Net per share/book value 10.0 % 22.2 % 34.5 % 10.2 %
Dividend yield 4.45 % 1.78 % 1.76 % 3.65 %
Current assets to

current liabilities 2.9 ϫ 4.3 ϫ 1.7 ϫ 3.4 ϫ
Working capital/debt Very large 5.6 ϫ no debt 3.4 ϫ
Earnings growth per share:
1968–1970 vs. 1963–1965 + 81% + 87% + 135% +14 %
1968–1970 vs. 1958–1970 +400% +250% Very large +132%
C. Price Record
1936–1968 Low
3
⁄4 1
1
⁄8 3
5
⁄8
High 50
3
⁄4 61
1
⁄2 66 58
1
⁄4
1970 Low 18
5
⁄8 42
1
⁄8 41 23
1
⁄2
1971 High 29
3
⁄8 78

3
⁄4 72 44
3
⁄8
1. Profitability. (a) All the companies show satisfactory earnings
on their book value, but the figures for Emerson and Emery are
much higher than for the other two. A high rate of return on
invested capital often goes along with a high annual growth rate in
earnings per share.* All the companies except Emery showed bet-
ter earnings on book value in 1969 than in 1961; but the Emery fig-
ure was exceptionally large in both years. (b) For manufacturing
companies, the profit figure per dollar of sales is usually an indica-
tion of comparative strength or weakness. We use here the “ratio of
operating income to sales,” as given in Standard & Poor’s Listed
Stock Reports. Here again the results are satisfactory for all four
companies, with an especially impressive showing by Emerson.
The changes between 1961 and 1969 vary considerably among the
companies.
2. Stability. This we measure by the maximum decline in per-
share earnings in any one of the past ten years, as against the aver-
age of the three preceding years. No decline translates into 100%
stability, and this was registered by the two popular concerns. But
the shrinkages of eltra and Emhart were quite moderate in the
“poor year” 1970, amounting to only 8% each by our measurement,
against 7% for the DJIA.
3. Growth. The two low-multiplier companies show quite satis-
factory growth rates, in both cases doing better than the Dow Jones
group. The eltra figures are especially impressive when set
against its low price/earnings ratio. The growth is of course more
impressive for the high-multiplier pair.

4. Financial Position. The three manufacturing companies are in
sound financial condition, having better than the standard ratio of
$2 of current assets for $1 of current liabilities. Emery Air Freight
has a lower ratio; but it falls in a different category, and with its fine
record it would have no problem raising needed cash. All the com-
panies have relatively low long-term debt. “Dilution” note: Emer-
son Electric had $163 million of market value of low-dividend
A Comparison of Four Listed Companies 333
* This measure is captured in the line “Net per share/book value” in Table
13-2, which measures the companies’ net income as a percentage of their
tangible book value.
convertible preferred shares outstanding at the end of 1970. In
our analysis we have made allowance for the dilution factor in
the usual way by treating the preferred as if converted into com-
mon. This decreased recent earnings by about 10 cents per share, or
some 4%.
5. Dividends. What really counts is the history of continuance
without interruption. The best record here is Emhart’s, which has
not suspended a payment since 1902. eltra’s record is very good,
Emerson’s quite satisfactory, Emery Freight is a newcomer. The
variations in payout percentage do not seem especially significant.
The current dividend yield is twice as high on the “cheap pair” as
on the “dear pair,” corresponding to the price/earnings ratios.
6. Price History. The reader should be impressed by the percent-
age advance shown in the price of all four of these issues, as mea-
sured from the lowest to the highest points during the past 34
years. (In all cases the low price has been adjusted for subsequent
stock splits.) Note that for the DJIA the range from low to high was
on the order of 11 to 1; for our companies the spread has varied
from “only” 17 to 1 for Emhart to no less than 528 to 1 for Emery

Air Freight.* These manifold price advances are characteristic of
most of our older common-stock issues, and they proclaim the
great opportunities of profit that have existed in the stock markets
of the past. (But they may indicate also how overdone were the
declines in the bear markets before 1950 when the low prices were
registered.) Both eltra and Emhart sustained price shrinkages of
more than 50% in the 1969–70 price break. Emerson and Emery had
serious, but less distressing, declines; the former rebounded to a
new all-time high before the end of 1970, the latter in early 1971.
334 The Intelligent Investor
* In each case, Graham is referring to Section C of Table 13-2 and dividing
the high price during the 1936–1968 period by the low price. For example,
Emery’s high price of 66 divided by its low price of 1/8 equals 528, or a
ratio of 528 to 1 between the high and low.
General Observations on the Four Companies
Emerson Electric has an enormous total market value, dwarfing
the other three companies combined.* It is one of our “good-will
giants,” to be commented on later. A financial analyst blessed (or
handicapped) with a good memory will think of an analogy
between Emerson Electric and Zenith Radio, and that would not be
reassuring. For Zenith had a brilliant growth record for many
years; it too sold in the market for $1.7 billion (in 1966); but its prof-
its fell from $43 million in 1968 to only half as much in 1970, and in
that year’s big selloff its price declined to 22
1
⁄2 against the previous
top of 89. High valuations entail high risks.
Emery Air Freight must be the most promising of the four compa-
nies in terms of future growth, if the price/earnings ratio of nearly 40
times its highest reported earnings is to be even partially justified.

The past growth, of course, has been most impressive. But these fig-
ures may not be so significant for the future if we consider that they
started quite small, at only $570,000 of net earnings in 1958. It often
proves much more difficult to continue to grow at a high rate after
volume and profits have already expanded to big totals. The most
surprising aspect of Emery’s story is that its earnings and market
price continued to grow apace in 1970, which was the worst year in
the domestic air-passenger industry. This is a remarkable achieve-
ment indeed, but it raises the question whether future profits may
not be vulnerable to adverse developments, through increased com-
petition, pressure for new arrangements between forwarders and air-
lines, etc. An elaborate study might be needed before a sound
judgment could be passed on these points, but the conservative
investor cannot leave them out of his general reckoning.
Emhart and eltra. Emhart has done better in its business than in
the stock market over the past 14 years. In 1958 it sold as high as 22
times the current earnings—about the same ratio as for the DJIA.
Since then its profits tripled, as against a rise of less than 100% for
the Dow, but its closing price in 1970 was only a third above the
A Comparison of Four Listed Companies 335
* At the end of 1970, Emerson’s $1.6 billion in market value truly was “enor-
mous,” given average stock sizes at the time. At year-end 2002, Emerson’s
common stock had a total market value of approximately $21 billion.