What is Owner Earnings and Cash Profits?

Owner Earnings and Owners’ Cash Profits are similar types of cash flow for analysis of businesses and stocks. These metrics provide important insight into the cash flow of the entity, particularly the cash flow available for the owners.

Owner Earnings

The value analyst must view a company differently than the accountant whose task is to document. GAAP (Generally Accepted Accounting Principles) may not provide a true picture for equity valuation due to accounting entries that distort profitability.

Owner Earnings is a cash flow concept popularized by Warren Buffett in his 1986 Berkshire Hathaway company letter to shareholders. Consider at this time that companies were not required to produce a cash flow statement.
Buffet described how he and Charlie Munger analyzed cash flow:

Owner Earnings Calculation

Owner Earnings = (a) Net Income plus (b) depreciation, depletion, amortization, and other non-cash charges minus (c) average annual maintenance capital expenditures

(a) Found in the Income Statement
(b) Found in the Cash Flow Statement (now – not in 1986)
(c) is harder to calculate. Buffet had to calculate this metric without the benefit of a cash flow statement. This is his description:
“( 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.

(If the business requires additional working capital to maintain its competitive position and unit volume, the increment also should be included in ( c) . However, businesses following the LIFO inventory method usually do not require additional working capital if unit volume does not change.)”

The challenge of owner earnings is that companies generally do not report a separate number for maintenance capex. Using estimates and averages can mean that an analysts best “guesstimate” will not be as accurate as it could be.

Since there is no easy means to determine what part of capital expenditures (CAPEX) is maintenance and what is for “growth”; it makes sense for many investors to just use the total CAPEX (available in the cash flow statement). This is a more conservative figure, and sufficient for most investors:

financeOwner Earnings = Net Income + Non-Cash Expenses [depreciation & amortization +/- one-time items]– Capital Expenditures