In his 1986 letter to Berkshire shareholders, Buffett argued that reported earnings — the profit at the bottom of the income statement — is not the number an owner should value a business on. He proposed a different one, which he called owner earnings: the cash the business could hand you each year without becoming a weaker business for it.
- Net profit
- reported profit after tax
- Non-cash charges
- depreciation, amortisation, impairments added back
- Maintenance capex
- the capital spending needed to sustain current volumes — not growth spending
Example: A company earning ₹100 cr, with ₹40 cr depreciation and ₹30 cr of genuine maintenance capex, has owner earnings near ₹110 cr — well above profit, because most of its capex is growth, not upkeep.
The maintenance-capex problem
Total capex is a single reported line. But some of it merely replaces worn-out machines to hold today’s output, while the rest builds new capacity to grow. Only the first kind is a true cost of the current business; the second is optional, a bet on the future. Free cash flow lumps them together and so understates the cash a growing company really spares; owner earnings tries to strip the growth spending out.
- Depreciation as a proxy — in a steady business, replacing what wears out costs roughly what depreciation charges, so depreciation is a common first estimate of maintenance capex.
- Management commentary — concalls and annual reports sometimes split "maintenance" from "growth" or "expansion" capex; use their number when given.
- Capex-to-sales in a flat year — what a company spent in a year it did not grow is a decent read on its upkeep bill.
- Operating cash flow minus ALL capex
- Punishes a company for investing to grow
- Fully derivable from the cash-flow statement
- Can be negative for a healthy, fast-growing firm
- Profit plus non-cash charges minus MAINTENANCE capex
- Isolates the cash the existing business spares
- Needs a judgement call on maintenance capex
- Aims at sustainable, distributable cash
A company reports ₹200 cr profit, ₹80 cr depreciation, and ₹150 cr total capex, of which management says ₹70 cr is maintenance. Roughly what are its owner earnings?
Buffett kehte hain income statement ka bottom-line profit se business value mat lagao. Owner earnings = profit + depreciation (non-cash) − maintenance capex — matlab woh cash jo business khud ko kamzor kiye bina aapko de sakta hai. Pech sirf ek: company total capex batati hai, "maintenance" vs "growth" ka split nahi. Free cash flow poora capex kaat deta hai (growth ki bhi saza), owner earnings sirf maintenance kaat ta hai. Maintenance capex ka andaaza aksar depreciation ke aas-paas. Precise-galat se accha approximate-sahi.
- Owner earnings is the cash a business can distribute without weakening itself.
- It is profit plus non-cash charges minus maintenance capex and working-capital growth.
- Maintenance capex is never reported, so the figure is an informed estimate, not a fact.
- Unlike free cash flow, it does not penalise a company for optional growth spending.
- Aim to be approximately right about a range rather than precisely wrong about a point.
Mark it done to track your progress through the curriculum.
Common questions
Short, direct answers to what people ask about this topic.
- what is owner earnings
- Owner earnings is Warren Buffett’s estimate of the cash a business could distribute to its owners each year without weakening its competitive position. He defined it in the 1986 Berkshire letter as reported profit, plus depreciation and other non-cash charges, minus the capital spending the business genuinely needs to maintain its current volumes — not its total capital spending. The subtle, decisive term is that maintenance figure, which companies never report separately.
- owner earnings vs free cash flow
- Free cash flow subtracts all capital expenditure from operating cash flow; owner earnings subtracts only maintenance capital expenditure. So a company investing heavily to grow will show low or negative free cash flow while its owner earnings can be healthy, because the growth spending is a choice, not a cost of staying in business. Owner earnings tries to isolate the sustainable cash the existing business throws off, which is what a valuation should be built on.
- how to calculate owner earnings
- Start with net profit, add back depreciation, amortisation and other non-cash charges, then subtract maintenance capex and any increase in working capital the business needs to keep running. Since maintenance capex is not disclosed, you estimate it — a common rough proxy is depreciation, on the logic that a steady-state business roughly replaces what it wears out. The estimate is imprecise by nature, so Buffett’s point was that an approximately right owner-earnings figure beats a precisely wrong accounting one.
- why did buffett prefer owner earnings to reported profit
- Because reported profit can be inflated by accounting choices and says nothing about the capital a business must keep pouring in just to stand still. Two companies can report the same profit while one needs constant heavy reinvestment to hold its position and the other needs almost none — the second is worth far more, and only a cash measure that charges for maintenance capital reveals the gap. Owner earnings was Buffett’s attempt to value a business by the cash it can actually spare.