In around two minutes you will know what is Warren Buffett's Owner's Earnings. You will get both professional definition and easy explanation. No intro, no outro, straight to the point.

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Owner Earnings is a better representation of what a company actually receives as earnings.

Owner earnings is an advanced version of net income. And, therefore, can be used to calculate earnings per share and p/e ratios which represent more realistic picture.

And if you are not sure what net income, earnings per share, or p/e ratio means, feel free to watch my previous videos.

Net income is basically money that is left for the company after all the possible expenses are paid out. But sometimes, this is not the real amount that a company actually might end up retaining.

That is why Warren Buffett came up with so called owner earnings.

And its formula is net income plus depreciation and amortization, plus/minus other non-cash charges, minus annual maintenance capital expenditures, plus/minus changes in working capital.

The formula might sound complicated, but I am going to break it down now.

Net income can be found on the income statement.

Depreciation and amortization are located on the cash flow statement.

Other non-cash charges are also on the cash flow statement. And these are all the possible charges that do not involve cash transactions, such as for example, employee stock compensation.

Then comes annual maintenance capital expenditures. Capital expenditures are located on the cash flow statement as well. But we only need that part that is related to maintenance. Because capital expenditures can be divided in two parts. First, buying assets and expanding business. Second, maintaining working condition of these assets, which is essential, but does not expand business activities.

You can use Bruce Greenwald’s method of calculating maintenance capex, but it is pretty complicated and can be inaccurate. That is why if you want to be safe, you can go conservative method and use total capital expenditures instead.

And finally, changes in working capital. Which is basically the difference between changes in current assets and changes in current liabilities. Which can also be found on the income statement.

The result of all these calculations will be owner earnings. Which is according to Warren Buffett are much better representation of earnings that are retained within the company.

You can then divide it by total number of shares outstanding to calculate more accurate EPS. And then use this EPS to find the P/E ratio of a company. Which will most likely be different from traditional EPS and P/E ratios.

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*None of this is meant to be construed as investment advice, it's for entertainment purposes only. Links above include affiliate commission or referrals. I'm part of an affiliate network and I receive compensation from partnering websites. The video is accurate as of the posting date but may not be accurate in the future.

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