Buffett's measure of a business's true cash generation: net income plus depreciation and amortisation, minus the capital expenditure required to maintain competitive position.
“Reported earnings per share are a beginning, not an end, of the investment analyst's job. The analyst must look through the reported figures to find the true economic picture of the business.”
— Warren Buffett
Deeper Explanation
Reported earnings — the net income figure that appears in a company's income statement — are an accounting construct subject to a range of adjustments, estimates, and assumptions. Owner earnings, a concept Buffett introduced in his 1986 letter to Berkshire shareholders, strips away the accounting noise to ask a simpler question: how much cash can this business actually hand to its owners each year? The formula is: net income, plus depreciation and amortisation (non-cash charges that reduce reported income but not cash), minus the capital expenditure required to maintain the business's competitive position. That final subtraction is the crucial element that reported earnings ignore entirely. A business may show strong profits on paper while spending most of those profits on capital expenditure just to stay in place — new equipment, store refurbishments, technology upgrades — leaving little true cash for owners. The distinction between maintenance capex (keeping the business where it is) and growth capex (expanding it) is important but difficult. Most companies do not disclose this split. Skilled analysts estimate it by examining historical capex levels, management commentary, and the relationship between capex and revenue. The discipline of making this estimate forces engagement with the operational realities of the business in a way that simply reading reported earnings does not. Owner earnings matter because compounding only works if the cash is real. A business that reports $100m in earnings but must reinvest $90m just to maintain position has $10m in owner earnings — very different from a business that reports $100m and requires only $20m in maintenance capex, leaving $80m truly free. Over a decade, this difference is enormous. The businesses with the highest owner earnings relative to their reported earnings — those that generate cash without requiring constant heavy reinvestment — are the most powerful compounding machines in existence.
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