What is Owner Earnings? (The Warren Buffett Guide)

Most investors look at Net Income or EPS (Earnings Per Share) to judge a company’s health. But under standard accounting rules, these numbers can be misleading.

Accounting profit doesn’t always equal real profit. It doesn’t tell you how much cash actually lands in the owner’s pocket at the end of the year.

In this guide, we will break down Warren Buffett’s 1986 definition of Owner Earnings, update the formula for modern financial statements, and walk through real-world calculation examples for Microsoft and Amazon.

The Difference Between Accounting Earnings and Owner Earnings

In his 1986 letter to Berkshire Hathaway shareholders, Warren Buffett introduced a concept that changed value investing forever. He argued that reported earnings (Net Income) are often distorted by accounting rules.

Buffett wanted to know the distributable cash—the money an owner could take home after paying for all the necessary upkeep of the factory or business. He famously stated:

“These represent (a) reported earnings plus (b) depreciation, depletion, amortization, and certain other non-cash charges… less (c) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position.”

The Modern Owner Earnings Formula

While Buffett’s original paragraph is dense, we can translate it into a simple formula using modern financial statements (the Cash Flow Statement and Income Statement).

Breaking Down the Variables:

• Net Income: Found on the Income Statement.
• Depreciation & Amortization: Added back because it is a non-cash expense (you didn’t write a check for it this year).
• Maintenance Capex: The cash required just to keep the lights on and equipment running (not for growth).
• Changes in Working Capital: Adjusts for cash tied up in inventory or receivables.

The Challenge of Maintenance Capex

The hardest part of this calculation is separating Maintenance Capex (money spent to stay competitive) from Growth Capex (money spent to expand). Financial statements rarely separate them.

Two Ways to Estimate It:

1. The Greenwald Method: Use depreciation as a proxy for maintenance capex.
2. The Conservative Method: Use the full Capex figure. It’s better to be conservative and undervalue a stock than to underestimate expenses and overpay.

Real World Example: Microsoft (MSFT)

Let’s look at a Trailing Twelve Month (TTM) example for Microsoft to see the formula in action.

• Net Income: $12,273M
• (+) D&A: $5,990M
• (+) Non-Cash Charges: $2,598M
• (-) Capex: $6,018M
• (-) Change in Working Capital: $1,471M (Note: Negative change reduces FCF)

Microsoft Owner Earnings = $13,372 Million

Real World Example: Amazon (AMZN)

Amazon is unique because it often has positive working capital changes. They collect cash upfront from customers before paying suppliers.

• Net Income: $328M
• (+) D&A: $5,909M
• (+) Non-Cash Charges: $2,001M
• (-) Capex: $4,424M
• (+) Change in Working Capital: $6,422M

Amazon Owner Earnings = $10,236 Million

Frequently Asked Questions

What is the difference between Free Cash Flow (FCF) and Owner Earnings?

FCF typically uses “Operating Cash Flow minus Capital Expenditures.” Owner Earnings is more nuanced; it specifically attempts to isolate maintenance capex and adjusts carefully for working capital to find the true “distributable” cash.

Why is Working Capital added or subtracted?

If a business needs to buy more inventory to grow (negative working capital), that eats up cash. If a business gets paid upfront (positive working capital), that generates cash. Buffett adjusts for this to see the real cash reality.

Final Thoughts

Owner Earnings requires a bit more work than simply reading the P/E ratio, but it offers a far more accurate picture of a company’s intrinsic value. It separates the accounting noise from the cash reality.