Owner Earnings Framework
Valuing businesses with owner earnings
The Owner Earnings Framework is a method for valuing businesses by calculating owner earnings, which represent reported earnings plus non-cash charges, less the average annual amount of capitalized expenditures required to maintain the business's competitive position. This framework is useful for investors and managers seeking to evaluate business performance and make informed decisions.
- Owner earnings are a more relevant metric than GAAP earnings for valuation purposes.
- Non-cash charges, such as depreciation and amortization, should be added back to reported earnings.
- Capitalized expenditures required to maintain the business's competitive position should be subtracted from owner earnings.
- Calculate reported earningsStart with the business's reported earnings, as stated in the financial statements.Pro tipEnsure that reported earnings are adjusted for any non-recurring items or one-time charges.WarningBe cautious of businesses with high levels of debt or unusual accounting practices.
- Add back non-cash chargesAdd back non-cash charges, such as depreciation, depletion, and amortization, to reported earnings.Pro tipConsider the business's industry and competitive position when evaluating non-cash charges.WarningBe aware of businesses with high levels of non-cash charges, as these may indicate underlying issues.
- Subtract capitalized expendituresSubtract the average annual amount of capitalized expenditures required to maintain the business's competitive position from owner earnings.Pro tipConsider the business's growth prospects and industry trends when evaluating capitalized expenditures.WarningBe cautious of businesses with high levels of capitalized expenditures, as these may indicate declining competitiveness.
Warren Buffett used the example of Scott Fetzer, a business acquired by Berkshire Hathaway, to illustrate the importance of considering non-cash charges and capitalized expenditures when evaluating business performance.
Warren Buffett introduced the Owner Earnings Framework in his 1986 shareholder letter, where he discussed the importance of considering non-cash charges and capitalized expenditures when evaluating business performance.