Warren Buffett's Owner's Earnings
๐ต There's a common theme in the recent letters of Warren Buffett to the shareholders of Berkshire Hathaway, $BRK.B the profits according to GAAP (Generally Accepted Accounting Principles) are not accurate. The problem with the GAAP earnings of Berkshire Hathaway is that it takes into consideration unrealized capital gains. But these are not real profits as only when you sell the stocks, you make an actual profit. ๐๐ค๐ฌ ๐๐ค ๐ฌ๐ ๐๐๐ก๐๐ช๐ก๐๐ฉ๐ ๐ฉ๐๐ ๐ง๐๐๐ก ๐ฅ๐ง๐ค๐๐๐ฉ๐จ ๐ค๐ ๐ ๐๐ค๐ข๐ฅ๐๐ฃ๐ฎ?
๐ฐ Usually, two numbers are often mentioned in the news about how a company is doing, ๐ง๐๐ซ๐๐ฃ๐ช๐๐จ ๐๐ฃ๐ ๐๐๐ (Earnings Per Share). While revenues are important, what really matters are profits. Here also, accounting rules are very important. In recent years, the revenues of McDonald's $MCD have been going down. It is because they are changing their business model. But as long as profits are increasing, we should not worry.
๐ฎ ๐๐ค ๐๐๐ก๐๐ช๐ก๐๐ฉ๐ ๐ฃ๐๐ฉ ๐๐ฃ๐๐ค๐ข๐ (๐๐ผ๐ผ๐ ๐ฅ๐ง๐ค๐๐๐ฉ๐จ), non-cash expenses such as amortization are also included. But in reality, these expenses don't take cash away from the business. This is what I saw with GameStop $GME when I invested in the company. Most of their expenses were from impairment of goodwill, which did not affect the operations of the business at all. A better way to calculate the actual profits of a company is to look at cash flows.
๐ฐ Warren Buffett goes a step further, from the cash flows, he calculates the actual cash flows which the company can return to shareholders through dividends or buybacks or reinvestments, and calls it ๐ค๐ฌ๐ฃ๐๐ง'๐จ ๐๐๐ง๐ฃ๐๐ฃ๐๐จ. For example, owner's earnings should ignore stock compensation unlike free cash flow.
๐ There is ๐ฃ๐ค ๐๐ญ๐๐๐ฉ ๐๐ค๐ง๐ข๐ช๐ก๐ to calculate the owner's earnings of a company. For example, most of the time, non-recurring incomes such as divestitures should be ignored according to Security Analysis of Benjamin Graham. But when I calculated the earnings of UNFI $UNFI I added them since they are using this cash to repay a debt which they took to make these acquisitions.
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