Owner earnings explained

Owner earnings is Warren Buffett's answer to a simple problem: reported profit doesn't tell you how much cash an owner can actually take out of a business. It's one of the most useful concepts in value investing — and it hinges on one genuinely difficult number.

The problem it solves

When most investors judge a company, they look at net income — the bottom line of the income statement. But Buffett argued that reported earnings are often distorted by accounting rules, and don't reflect the real cash an owner could pocket after paying to keep the business running. In his 1986 letter to Berkshire Hathaway shareholders, he proposed a better measure and called it owner earnings.

The idea: work out the cash a business genuinely throws off to its owners, after spending whatever is needed to maintain its competitive position. Not accounting profit — distributable cash.

The formula

Walking through it: start with net income. Add back depreciation and amortisation, because those are accounting deductions, not actual cash leaving the business this year. Then subtract maintenance capital expenditure — the cash the company must spend just to keep its existing operations and competitive position intact.

That maintenance-capex distinction is the whole point. A business can report a healthy profit while quietly ploughing most of it back into equipment simply to stand still. Owner earnings strips that away to show what's genuinely left over.

The part everyone struggles with

Maintenance capital expenditure is rarely stated in the accounts. Companies report total capex — but that mixes together two very different things: spending to maintain the business, and spending to grow it. Only the maintenance portion should be subtracted, because growth capex is optional and builds future value.

Since companies don't split it out, you have to estimate. A common approach is to average capital spending over a full business cycle, since capex is lumpy — a big plant refit lands in one year, then little for several. Buffett himself stressed using the average annual figure for exactly this reason. As Keynes put it, it's better to be roughly right than precisely wrong.

Owner earnings vs the alternatives

Owner earnings sits between two flawed measures. Net income is distorted by accrual accounting and non-cash items. Free cash flow punishes companies for growth spending, because it subtracts all capex including the growth portion. Owner earnings tries to capture only maintenance capex — the truest picture of sustainable, distributable cash.

Understanding all three, and why they differ, makes you sharply better at reading a cash flow statement and estimating what a business is really worth.

Why it matters for valuation

Because owner earnings approximates the real cash a business generates, it's a sounder foundation for estimating intrinsic value than reported profit. A company whose owner earnings consistently exceed its net income is often higher quality than the headline figures suggest — and one where the reverse is true deserves a much closer look.

Common questions