When people first hear about “owner’s earnings,” the term can sound like another piece of Wall Street jargon, something thrown around to impress rather than to clarify. But Warren Buffett and Charlie Munger use it for a reason. Owner’s earnings cut through the accounting noise and tell you, the investor, what really matters: how much cash a business actually generates for its owners after it takes care of itself.
Understanding this difference is like switching from looking at a company as an accountant would to looking at it like a business owner would. Let’s break this down step by step.
What Are Owner’s Earnings?
Buffett defines owner’s earnings as:
Net Income + Depreciation + Depletion + Amortization – Capital Expenditures – Changes in Working Capital
That’s a mouthful. In plain English, it means:
- Start with profit (net income).
- Add back paper charges (depreciation, amortization).
- Subtract real cash spending to maintain and grow the business (CapEx).
- Adjust for working capital (cash tied up in inventory, receivables, or freed up by delaying payables).
The result: the actual cash the business could hand to its owners without hurting itself.
Why Net Income Isn’t Enough
If you only look at net income, you’re relying on accounting’s version of reality. And accounting has its own rules. For example:
- Depreciation: Accountants spread out the cost of big purchases over years, even though the cash was spent upfront.
- Amortization: Same idea, but for intangible assets like patents.
So net income often understates cash flow in the short term by subtracting expenses that don’t actually come out of the business this year.
That’s why Buffett says: “Add it back.” He wants reality, not smoothing.
The Disney Example
Let’s take Disney building a new theme park expansion for $30 billion.
- Year 1 (Purchase): Disney spends $30B cash. Accountants don’t record all $30B as an expense. Instead, they say, “We’ll spread it out as $3B depreciation each year for 10 years.”
- Years 2–10 (Depreciation Years): Disney’s income statement shows a $3B expense every year. But no new cash left the company, that $30B was spent upfront.
From an accountant’s view, Disney’s net income gets reduced by $3B every year.
From Buffett’s view, that’s misleading. He says: “Cash already left. Stop pretending $3B is leaving every year.”
That’s why he adds depreciation back. But then he subtracts real CapEx, the actual cash Disney spends this year on new rides, repairs, movies, or tech upgrades.
So it’s not canceling out. It’s a swap: take out the fake expense (depreciation), replace it with the real expense (CapEx).
The Laptop Analogy
Think about buying a $200 laptop.
- An accountant spreads the cost: “$10 expense per year for 20 years.”
- Buffett says: “No, I paid $200 upfront. Stop acting like $10 leaves every year.”
What matters today isn’t the accounting depreciation. It’s the real upkeep: a $50 battery replacement, a $100 memory upgrade, or eventually buying a new one.
That’s exactly how he treats companies like Disney.
Owner’s Earnings Formula in Action
So the simplified Buffett formula looks like this:
- Net Income (already reduced by depreciation).
- + Depreciation/Amortization (add it back, not real cash this year).
- – Capital Expenditures (actual cash spent to maintain/grow assets).
- – Working Capital Changes (cash tied up or freed in operations).
= Owner’s Earnings (cash the owner could pocket).
This is the number Buffett trusts most.
Why Accountants Do It Differently
Accountants aren’t wrong. They’re just doing their job: smoothing earnings to fairly represent costs over time.
If Disney expensed $30B in Year 1, the books would look insane: one awful year followed by nine “perfect” years. Investors would be whiplashed. Depreciation smooths that out.
So accounting is about consistency. Buffett’s lens is about cash reality.
Why Buffett Ignores EBITDA
This is also why Buffett and Munger hate EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).
- EBITDA says: “Pretend we didn’t have to pay interest, taxes, or replace equipment.”
- Buffett: “Reality check, the tooth fairy isn’t paying for CapEx.”
EBITDA can make a business look more profitable than it really is. That’s great for investment bankers pitching a deal. But useless for someone actually trying to own the business.
DCF: Wall Street vs. Buffett
Another area where Buffett parts ways with Wall Street is Discounted Cash Flow (DCF).
- Wall Street DCF: 10+ years of projections, dozens of assumptions (growth rates, discount rates, margins, terminal values). Change one number slightly, and billions in valuation swing. It looks precise but it’s fragile.
- Buffett’s DCF in Spirit: He strips it down to basics.
- “What are owner’s earnings now?”
- “Are they durable and growing?”
- “At today’s price, do those earnings give me a strong, safe return (say 10–15%) compared to Treasuries?”
Example: If Coca-Cola earns $10B a year in owner’s earnings:
- Buy Coke for $100B → 10% earnings yield = attractive.
- Buy Coke for $200B → 5% yield = too expensive.
That’s a DCF in spirit. It’s valuation by common sense, not spreadsheets.
Accountant vs. Buffett: Side-by-Side
| Scenario | Accountant’s View | Buffett’s View |
|---|---|---|
| $30B park expansion | Spread cost as $3B/year depreciation | Count $30B as gone in Year 1 |
| Years 2–10 | Subtract $3B/year depreciation from net income | Add back depreciation (not cash), subtract real CapEx this year |
| Balance sheet | Asset shrinks by $3B/year until fully depreciated | Doesn’t care if books say $0; cares if rides still bring in cash |
| Mindset | Smooth earnings, consistency | Cash reality, owner’s perspective |
Why This Matters for Investors
Most people get lost in terminology, EBITDA, DCF, adjusted earnings. Buffett ignores the noise. He focuses on what matters:
- Cash the business generates for owners.
- Durability of that cash.
- Buying it at a price with margin of safety.
That’s why he’s Buffett. He thinks like a business owner, not like an accountant or a Wall Street analyst.
Final Thought: Think Like an Owner
If you want to invest the Buffett way, you don’t need 200-line Excel sheets. You need a clear head and common sense:
- How much cash is this business really generating?
- Is it durable? Does it have a moat?
- At today’s price, do those earnings give me a safe, attractive return?
That’s owner’s earnings. That’s Buffett’s edge. And it’s an edge any investor can adopt, if they stop thinking like accountants and start thinking like owners.
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The Broke College Student 
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