Recently I became acquainted online with Hewitt Heiserman Jr. In a gentleman’s manner, he wrote me a very gracious and encouraging note concerning my book, “Choose Stocks Wisely.”

Hewitt is very accomplished and distinguished in the world of investing, and is often referenced. He has been quoted in TheStreet.com, The Wall Street Journal, BusinessWeek, CBS MarketWatch, Business 2.0, Better Investing, The Motley Fool, Complete Growth Investor, Barron’s, and the Haverford Trust Company Adviser.

The purchase of a stock security is the purchase of an equity stake. Thus, analysis of the existing value of the equity (as shown on the balance sheet) is critical to proper risk assessment and the attempt to avoid overpaying for that equity stake. As you know, this is a central theme of my book. Also, I mention repetitively in “Choose Stocks Wisely” that stock prices are driven by earnings.

Hewitt’s 2004 book, “It’s Earnings That Count: Finding Stocks with Earnings Power for Long-Term Profits“is a great resource for analyzing the earnings reflected on the corporate income statement for quality and potential durability. Recognizing that earnings can be “managed accounting-wise” such that a company can appear to be profitable and yet be presenting profit numbers that are of low quality, he shows how his two alternative income statements can be utilized to ascertain the true quality of the earnings number. Generally accepted accounting principles (GAAP) dictates preparation of the income statement we all receive per company financial filings and GAAP’s rule-based accrual income measurement basis leaves avenues for earnings management that can lead to overly optimistic earnings numbers. If the earnings are of poor quality, the company’s whole financial situation will be overstated. Heiserman deals with this head-on and again presents a way to assess the quality of earnings.

Since earnings drive future stock prices, we have to be involved with companies that not only present solid performance numbers in terms of the sheer numbers themselves, but also numbers that can serve as realistic performance outcomes. That is, if the numbers are of low quality, how can we trust further assessment when it comes to evaluating value and potential? How can we have confidence in assessing a company’s ability to be a genuine producer and potential producer for the long-term? Heiserman’s two alternate income statements, called the defensive income statement and the enterprising income statement, combine to form the two dimensions for his two-dimensional Earnings Power Chart. The sum of defensive profits and enterprising profits is a company’s earnings power. Better earnings power is indicative of better earnings quality.

I surely hope you will give Heiserman’s book a read if you have not already. By addressing the issue of how to assess the quality of earnings, his work adds much to the theme of properly assessing the financial statements in the context of stock investment decision-making.