Owner Earnings
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In 1986, Warren Buffett detailed his valuation method. He stated that what he used to determine income was something called Owner Earnings. He defined owner earnings as follows:
- "These represent (a) reported earnings plus (b) depreciation, depletion, amortization, and certain other non-cash charges...less (c) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume....Our owner-earnings equation does not yield the deceptively precise figures provided by GAAP, since (c) must be a guess - and one sometimes very difficult to make. Despite this problem, we consider the owner earnings figure, not the GAAP figure, to be the relevant item for valuation purposes...All of this points up the absurdity of the 'cash flow' numbers that are often set forth in Wall Street reports. These numbers routinely include (a) plus (b) - but do not subtract (c)."[1]
Buffett's description of owner earnings is very similar to free cash flow. However, it should be noted that he averages capital expenditures over several years, rather than using a single year's value. Also, he is concerned with the capital expenditures necessary to maintain position, not expenditures used for growth.
