Owner's earnings: Warren Buffett's favorite measure

2026-07-27 · By Lubin Danilo, founder of Lubin Investment

Owner's earnings, defined by Warren Buffett in 1986, is calculated as: net income plus depreciation and other non-cash charges, minus only the capital expenditures NEEDED to maintain the business's competitive position and current volume (not total investment, which often includes growth spending).

Why accounting profit and classic free cash flow are not enough

The net income a company reports is an accounting measure: it deducts from revenue charges that are not always real cash outflows (depreciation, for instance, spreads the cost of an already-paid purchase over several years). The free cash flow I use in my method (cash generated by operations, minus total capital expenditures) already fixes much of this problem. But it remains imperfect for one specific reason: it treats ALL capital expenditures the same way, whether they replace a worn-out machine or build a brand new plant to grow.

Warren Buffett identified this problem as early as 1986, in one of the most cited annual letters to Berkshire Hathaway shareholders in investing history. His observation: two companies can post exactly the same free cash flow, yet a very different economic reality if one spends to SURVIVE (replacing what wears out) and the other spends to GROW (opening new locations). He therefore invented his own measure to isolate what a business can truly distribute to its owner without compromising its ability to stay competitive.

The formula: net income, plus non-cash charges, minus only the investment truly needed

The formula Buffett wrote in black and white in his 1986 letter reads as follows: reported net income, PLUS depreciation and other accounting charges that are not real cash outflows, MINUS the average annual capital expenditure the business needs to fully maintain its competitive position and current sales volume (and, if needed, the increase in working capital to maintain that same position). The key word in the whole formula is 'maintain': Buffett only subtracts maintenance investment, not growth investment.

The example Buffett himself uses in his letters to illustrate this concept is See's Candies, the California confectioner Berkshire Hathaway acquired in 1972. See's Candies has a real advantage for this calculation: its value rests mostly on its brand and customer loyalty, not on costly plants to maintain. The company could therefore generate a high return on invested capital while needing very little maintenance capital each year, which brought its owner's earnings close to its accounting profit. That is exactly the opposite of a heavy industrial business (a steel mill, an airline), where maintaining plants or a fleet can swallow a huge share of the cash generated, just to stay in place, let alone grow.

Why my method does not use this distinction directly

I need to be honest about a practical limitation: my filter uses free cash flow in the classic sense (cash generated by operations minus TOTAL capital expenditures), not owner's earnings in Buffett's strict sense. The reason is simple: most companies do not disclose, in their financial reports, the share of their investments that maintains existing assets versus the share that funds growth. Buffett himself acknowledges in his 1986 letter that this figure often requires an experienced management's judgment, not a mechanical calculation from published accounting documents alone. Applying a distinction I cannot measure reliably and consistently across the thousands of stocks I cover would create more bias than precision.

Using total free cash flow, as I do, has one specific side effect: it slightly penalizes companies that invest heavily in growth (a larger share of their capex funds new locations, not just maintaining old ones), even when that growth is healthy and profitable. This is a deliberate tradeoff: I prefer a UNIFORM measure comparable across every stock in my screener, even if it means slightly underestimating the cash truly distributable by a fast-expanding company, rather than a measure that is more accurate in theory but impossible to calculate reliably in practice across a universe of several thousand stocks.

A real numerical example: Fastenal

Take Fastenal, the US industrial supplies distributor (screws, bolts, tools) I have already analyzed on my site. In fiscal year 2025, the company reported net income of $1,258.4 million, cash generated by operations (before investment) of $1,295.9 million, and total capital expenditures of $245.3 million. My classic free cash flow calculation therefore comes to $1,050.6 million ($1,295.9 million minus $245.3 million).

Fastenal keeps opening new distribution sites every year to expand its network, on top of maintaining the ones already in place. Part of that $245.3 million in capital expenditures therefore funds GROWTH (new warehouses, new delivery vehicles for new territories), not just maintaining the existing network. Fastenal does not publish in its reports the exact split between these two uses, which prevents me from calculating a precise owner's earnings figure in Buffett's strict sense. But the direction of the logic is clear: if part of that capex genuinely funds growth rather than plain upkeep, Fastenal's real owner's earnings would be HIGHER than my $1,050.6 million free cash flow, precisely because that figure subtracts spending that is not strictly needed to maintain the current business. This is exactly Buffett's warning: classic free cash flow tends to UNDERSTATE the cash truly distributable by a company growing in a healthy way.

How I use this distinction in my method

Even though I do not calculate owner's earnings in the strict sense, this lesson from Buffett shapes how I qualitatively read every case. When I see a company with high capex relative to its cash generation, I systematically ask: is this money building new capacity that will generate more cash tomorrow, or simply replacing aging assets without adding anything? I have already detailed this exact distinction (maintenance spending versus growth spending, and how to spot it in an annual report) in a dedicated article. A company that invests heavily BUT opens profitable locations deserves a more forgiving read than one that invests just as much simply to avoid falling behind. You can find Fastenal's detailed figures on the company's analysis page, dig deeper into the maintenance versus growth distinction in my dedicated article on capital expenditures, and my full methodology.

Owner's earnings, defined by Warren Buffett in 1986, is calculated as: net income + depreciation and non-cash charges, minus MAINTENANCE capex only (not total investment).
The key word in the formula is 'maintain': Buffett deliberately excludes growth investment (new locations, new capacity), which he distinguishes from the investment needed to stay at the same level.
Buffett's historical example: See's Candies, whose value rests on its brand rather than costly plants, had minimal maintenance capital, which brought its owner's earnings close to its accounting profit.
My method uses total free cash flow (not maintenance only) as a deliberate consistency choice: the maintenance/growth split is almost never disclosed by companies, a reliable and comparable calculation across thousands of stocks would be impossible.
Real example (Fastenal, fiscal 2025): net income $1,258.4M, cash from operations $1,295.9M, total capex $245.3M, classic free cash flow $1,050.6M. Part of that capex funds new site openings (growth): real owner's earnings are therefore likely higher than this figure.

FAQ

What is owner's earnings?

A measure invented by Warren Buffett in 1986: reported net income, plus depreciation and other non-cash charges, minus only the capital expenditures needed to maintain the business's competitive position and current volume (not total investment).

How does owner's earnings differ from classic free cash flow?

Classic free cash flow subtracts ALL capital expenditures, whether they maintain existing assets or fund growth (new locations, new capacity). Owner's earnings only subtracts the maintenance share, which often makes it higher for a healthily growing company.

Why does Warren Buffett use See's Candies as an example?

Because See's Candies' value rests mostly on its brand and customer loyalty, not on costly plants to maintain. The company therefore needed very little maintenance capital each year, which brought its owner's earnings close to its accounting profit, a textbook case to illustrate the concept.

Why doesn't my method use owner's earnings directly?

Because most companies do not publish the exact split of their investments between maintenance and growth. Buffett himself acknowledges this figure often requires an experienced management's judgment. I therefore use total free cash flow, a uniform measure comparable across the thousands of stocks in my screener, even if it means slightly underestimating the distributable cash of fast-growing companies.

Does classic free cash flow always understate owner's earnings?

Not always, but often for an expanding company: if part of its capex funds new locations rather than maintaining old ones, then its real owner's earnings would exceed my free cash flow, which subtracts that growth spending as if it were pure maintenance.

About the author

Written by Lubin Danilo, founder of Lubin Investment. A self-taught individual investor, I find fundamental analysis fascinating, and it has delivered excellent results. For three years now, my performance has beaten the S&P 500. But analyzing every stock took too much time: sites with incomplete data, calculation methods and criteria never aligned with mine. And spotting the best stocks was just as time-consuming, even with my own well-defined checklist. So I put my software development background to work to build this software, base my investment strategy on its results, and share it with people who share the same passion as me. It judges a company's quality and its price separately, using criteria drawn from the financial literature (Warren Buffett, Michael Mauboussin, Aswath Damodaran).