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Owner earnings is a valuation method detailed by
Warren Buffett Warren Edward Buffett ( ; born August 30, 1930) is an American business magnate, investor, and philanthropist. He is currently the chairman and CEO of Berkshire Hathaway Berkshire Hathaway () is an American multinational Multinational may ...
in
Berkshire Hathaway Berkshire Hathaway () is an American multinational Multinational may refer to: * Multinational corporation, a corporate organization operating in multiple countries * Multinational force, a military body from multiple countries * Multinational ...

Berkshire Hathaway
's annual report in 1986. He stated that the value of a company is simply the total of the net
cash flow A cash flow is a real or virtual movement of money Image:National-Debt-Gillray.jpeg, In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in ...
s (owner earnings) expected to occur over the life of the business, minus any reinvestment of earnings. Buffett defined owner earnings as follows: :"These represent (a) reported
earnings Earnings are the net benefits of a corporation A corporation is an organization—usually a group of people or a company—authorized by the State (polity), state to act as a single entity (a legal entity recognized by private and public law ...
plus (b)
depreciation In accountancy, depreciation refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the allocation in a ...

depreciation
, depletion,
amortization Amortization (or amortisation; ) is paying off an amount owed over time by making planned, incremental payments of principal Principal may refer to: Title or rank * Principal (academia) The principal is the chief executive and the chief academi ...
, 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 A cash flow is a real or virtual movement of money Image:National-Debt-Gillray.jpeg, In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in ...
' numbers that are often set forth in
Wall Street Wall Street is an eight-block-long street in the Financial District This is a list of financial districts in cities around the world. Background A financial district is usually a central area in a city where financial services firms suc ...

Wall Street
reports. These numbers routinely include (a) plus (b) - but do not subtract (c)."


Estimating Average Capital Expenditures

Average annual capital expenditures is, as Buffett mentions, an estimate. This number may be separated into maintenance capital expenditure (what's required to keep the business operating at current levels) and growth capital expenditure (what's required to grow the business). The most straightforward way to calculate maintenance capital expenditure is to simply use depreciation, amortization, and depletion. But those numbers don't necessarily reflect reality since depreciation schedules and the like don't necessarily line up with their actual useful lives. Similarly, simply using the most recent period's capital expenditure may not be representative of the annual capital expenditure required to run the business and it may also include a portion of "growth" capital expense. One way, as proposed by Bruce Greenwald, to approximate maintenance capital expenditure, for use in an owner earnings calculation is to use a ratio of capital expenditure to sales over multiple past years. As formulated by Greenwald, this approximation works by: # Sum of property, plant, and equipment (PPE) from the balance sheet for the past 5 years # Sum sales from the income statement for the past 5 years # Dividing the sum of PPE by the sum of sales to find the average ratio of PPE-to-sales # Multiply the PPE-to-sales ratio by the nominal increase or decrease in sales from the prior year to the current year to find growth capital expenditure # Subtract calculated growth capital expenditure from the current year's capital expense on the balance sheet to find maintenance capital expenditure.


See also

*
Berkshire Hathaway Berkshire Hathaway () is an American multinational Multinational may refer to: * Multinational corporation, a corporate organization operating in multiple countries * Multinational force, a military body from multiple countries * Multinational ...

Berkshire Hathaway
*
Business valuation Business valuation is a process and a set of procedures used to estimate the economic value In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), product ...

Business valuation
* Cash flow forecasting *
Valuation (finance) In finance Finance is a term for the management, creation, and study of money In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in ...
* Value investing


References


External links

* * {{DEFAULTSORT:Owner Earnings Berkshire Hathaway Management accounting Business terms Valuation (finance)