📖Warren Buffett

Owner Earnings

🌳 Advanced★★★★★

Owner earnings — not accounting earnings — reveal a business's true economic reality.

💬

Owner earnings are the relevant item for valuation purposes — not reported earnings.

— 1986 Berkshire Hathaway Letter to Shareholders，1986

🏠 Everyday Analogy

Just like running a restaurant: the ledger may show a monthly profit of 100,000 yuan, but after deducting rent, ingredients, and renovation costs, the cash that actually ends up in the owner’s pocket is the real gain. The same goes for investing. A company’s net profit is merely an accounting figure; only after subtracting the necessary investments to sustain operations does the cash truly available to shareholders become owner’s earnings.

📖 Core Interpretation

Owner's Earnings = Net Income + Depreciation & Amortization - Capital Expenditures. This represents the true cash attributable to shareholders.
💎 Key Insight：Reported earnings include non-cash charges and exclude necessary capital expenditures. Owner earnings strip away accounting fictions: start with net income, add back depreciation, subtract maintenance capex. This number tells you what a business truly generates for its owner — and it's the only figure that matters for valuation.

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❓ Why It Matters

Accounting profits can be manipulated, while owner's earnings more closely reflect a company's true cash-generating capacity.

🎯 How to Practice

Calculating owner earnings requires: 1. Adjusting for non-recurring items, 2. Estimating maintenance capital expenditures, and 3. Considering changes in working capital.

🎙️ Master's Voice

Owner earnings are the relevant item for valuation purposes—not reported earnings.
Buffett invented the "owner earnings" concept: net income plus depreciation minus required capital expenditures. Accounting earnings can be manipulated. Owner earnings show the real cash the business generates for owners. This is what Buffett uses to value every business.

⚔️ Practical Guide

✅ Decision Checklist

  • Have I calculated owner earnings (not just net income)?
  • Do I understand the maintenance capex requirements?
  • Is accounting income overstating or understating reality?
  • What cash can actually be extracted by owners?

📋 Action Steps

  1. Calculate: Net income + D&A - maintenance capex
  2. Study capital requirements over multiple years
  3. Compare owner earnings to reported earnings
  4. Use owner earnings in your valuation

🚨 Warning Signs

  • Valuing on accounting earnings alone
  • Ignoring capital requirements
  • Not understanding depreciation vs. real capex
  • Taking reported earnings at face value

⚠️ Common Pitfalls

✕A high EPS indicates a good company – EPS may be artificially inflated due to accounting adjustments.
✕Free cash flow is equivalent to owner's earnings - free cash flow does not differentiate between maintenance and growth capital expenditures.

📚 Case Studies

1
See's Candies (1972)
Accounting profits are not high, but capital expenditures are almost negligible.
✨ Outcome：Owner's Earnings are exceptionally high.
2
Airlines (1986)
The accounting profit appears favorable.
✨ Outcome：However, capital expenditures are substantial, resulting in very low owner's earnings.

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