Owner earnings


Owner earnings is a valuation method detailed by Warren Buffett in Berkshire Hathaway's annual report in 1986. He stated that the value of a company is simply the total of the net cash flows expected to occur over the life of the business, minus any reinvestment of earnings.
Buffett defined owner earnings as follows:

Estimating Average Capital Expenditures

Average annual capital expenditures is, as Buffett mentions, an estimate. This number may be separated into maintenance capital expenditure and growth capital expenditure. The most straightforward way to calculate maintenance capital expenditure is to simply use deprecation, 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:
  1. Sum of property, plant, and equipment from the balance sheet for the past 5 years
  2. Sum sales from the income statement for the past 5 years
  3. Dividing the sum of PPE to the sum of sales to find the average ratio of PPE-to-sales
  4. 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
  5. Subtract calculated growth capital expenditure from the current year's capital expense on the balance sheet to find maintenance capital expenditure.