Owner earnings (OE) 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 (owner earnings) expected to occur over the life of the business, minus any reinvestment of earnings.
Owners’ earnings, also known as cash flow for owners, remains one of the more accurate measures of how much money we can make from an investment and helps calculate intrinsic value.
The formula for owners’ earnings is as follows:
OE = Net income + Non-cash charges – Maintenance Capex +/- Changes in working capital Where the below:
- Non-cash = depreciation, amortization, impairment + other charges
- Maintenance Capex = Cash a company spends to maintain normal biz operations.
- Changes in working capital = adding the items under “Change in operating assets and liabilities” from the CF statement.
We will use a combination of cash flow statements to find the numbers.
To simplify some of this maintenance, the capex is an imprecise number that Buffett didn’t define precisely.
Many suggest different calculation methods; we will use the CF number to simplify.
Using $MSFT as our guinea pig for the year ending 2022. Below are the numbers taken from the financials:
- Net income = $72,738
- Non-cash = $16,260
- Capex = ($23,866)
- Changes in working capital = $446
Plugging in the numbers for $MSFT, we get:
Owners Earnings = $72,738+$16,260-$23,866+$446 = $65,578
Per share = $65,578 / 7,496 = 8.74
When compared to current P/FCF equals 8.70
Use these criteria to eliminate 95% of stocks:
Revenue growth 12%
Shares outstanding <2%
Net debt to FCF below 5x
Free cash flow growth +15%
Return on Invested capital +15%
Earnings per share growth +15%
12 companies that qualify: