Stock Valuation Demands Skepticism: Don’t Trust Earnings Alone

January 28, 2026 (MLN):  “Earnings tell a story; cash tells the truth; valuation demands skepticism,” an adage seems to challenges the pervasive investment orthodoxy, repeated ad nauseam by investment gurus and practitioners alike, that earnings alone drive stock value.

 For instance, Benjamin Graham remarked: “The value of a stock depends on the earning power of the company behind it.” While, James D. Sinegal, co-founder and long-time CEO of Costco Wholesale, echoed this philosophy by stating, “Take care of the business, and the stock price will take care of itself.”

Most investors, myself included, have internalized this philosophy. Not merely because it has been repeatedly emphasized in investment literature, but because we have witnessed, time and again, the rise and fall in stock price in tandem with the up and down in earnings, thus reinforcing the illusion of earnings as a reliable proxy for value.

The belief is deeply rooted in an unexamined assumption—that accrual-based earnings, regardless of their source, will inevitably materialize as cash. This obscures a critical caveat—that not all reported earnings are equal in quality, and many fail to translate into economic reality. And this is not an exception. Many corporate groups report profits that are little more than accounting constructs: non-cash gains arising from equity investments in subsidiaries and associates. These earnings inflate net income but provide no immediate liquidity and not even in foreseeable future. Thus, valuing stocks based on such earnings is, in essence, a gamble rather than a disciplined assessment of true value of a stock.

The Sum-of-the-Parts (SOTP) valuation framework mitigates this concern by disaggregating reported earnings into operating income and equity-accounted income from subsidiaries and other investments. Each subsidiary is valued separately on the basis of its standalone earnings or cash-flow characteristics, individual values are then consolidated to estimate the intrinsic value of the parent entity. The method gains accounting legitimacy from IFRS disclosures and valuation principles, particularly those set out in IFRS 8 (Segment Reporting) and IFRS 13 (Fair Value Measurement).

However, this does not change the fundamental reality: a substantial portion of reported earnings may be transient and, under accounting conventions, potentially never realized. Ignoring this ephemeral nature creates an illusion, making skepticism toward valuations both necessary and prudent.

The reality is uncomfortable, but can be mitigated if investors carefully assess earnings quality, distinguish cash from accrual, and examine the sustainability of reported profits to arrive at a more genuine valuation.

However, this discipline comes at a cost: investors may have to forgo potential returns arising from price volatility triggered by earnings announcements.

Mind, anything less is intellectual complacency disguised as investment discipline

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