Owner earnings

Warren Buffett on owner earnings

Warren Buffett has referred to the ‘owner earnings’ of a company as the true
measure of earnings. He has defined ‘owner earnings’ as:

Reported earnings + depreciation, amortization, other non-cash items - average
annual amount of capitalized spending on plant, machinery, equipment (and
presumably research and development).

Reasoning behind owner earnings

His thinking seems to go like this.

Depreciation

You should not consider depreciation because this is generally a fixed
percentage of an amount spent in the past that does not necessarily reflect the
true cost of replacing things when they are obsolete.

Amortization

Buffett has often criticised accounting amortisation of things such as
economic goodwill. Economic goodwill, including things such as brand name,
reputation, monopolistic or market dominance, might actually increase in value
rather than depreciate.

Capital expenditure

It is difficult to estimate true capital spending. Items may be deferred or
brought forward. Averaging actual expenditure is a more reliable guide of a
company’s true capital needs.