Owner Earnings
Warren Buffett · 1986
"The number that matters for valuation is not reported earnings or 'cash flow' but owner earnings: reported earnings, plus depreciation and other non-cash charges, minus the capital spending needed just to hold the business's competitive position. Skip the last subtraction and you are pricing the business as if it were the Pyramids."
Berkshire bought Scott Fetzer in January 1986. Under purchase accounting the same company, run by the same people, selling the same products, reported $28.6 million of earnings instead of $40.2 million — the difference being $11.6 million of new non-cash charges for stepped-up inventory, depreciation and goodwill that were not even tax-deductible. Buffett's question in the appendix to that year's letter was simple: did Berkshire buy a business earning $40 million or one earning $29 million? Both figures were GAAP-correct, and neither was the answer.
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Great, Good, and Gruesome Businesses
"A truly exceptional business must possess an enduring competitive advantage — an economic moat — that protects its high returns on invested capital from the relentless assault of free-market capitalism."