How Does HE think about Earnings?

Owner earnings 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 and its unit volume. If the business requires additional working capital to maintain its competitive position and unit volume, the increment also should be included in (c).

Our owner-earnings equation does not yield the deceptively precise figures provided by GAAP, since (c) must be a guess - and one sometimes very difficult to make. Despite this problem, we consider the owner earnings figure, not the GAAP figure, to be the relevant item for valuation purposes - both for investors in buying stocks and for managers in buying entire businesses. We agree with Keynes's observation: I would rather be vaguely right than precisely wrong.

Calculations of this sort usually do not provide pleasant news. Most managers probably will acknowledge that they need to spend something more than (b) on their businesses over the longer term just to hold their ground in terms of both unit volume and competitive position. When this imperative exists - that is, when (c) exceeds (b) GAAP earnings overstate owner earnings.Frequently this overstatement is substantial.

In many businesses particularly those that have high asset/profit ratios - inflation causes some or all of the reported earnings to become ersatz [fake, artificial, unreal]. The ersatz portion - lets call these earnings restricted - cannot, if the business is to retain its economic position, be distributed as dividends.

Were these earnings to be paid out, the business would lose ground in one or more of the following areas: its ability to maintain its unit volume of sales, its long-term competitive position, its financial strength.

No matter how conservative its payout ratio, a company that consistently distributes restricted earnings is destined for oblivion unless equity capital is otherwise infused.

Profits are the discretionary funds available to the owners of a business after providing for all costs required to maintain the ability of the enterprise to operate at current levels.

Such real profits must ultimately be reflected in spendable cash. Economic earnings measured over a fairly long period are equal to the amount of cash that can be taken out of a business, without hurting that business.

If a company distributes its earnings and as a result of that decision it is hurt in any of the following areas, then those earnings were not owner earnings: its ability to maintain its unit volume of sales, its long-term competitive position, or its financial strength

Buffett uses the concept of Onwer Earnings instead of Free Cash Flow

HE uses Owner Earnings to determine attractiveness of a BUSINESS as well as INVESTMENT

Value is destroyed, not created, by any business that loses money over its lifetime, no matter how high its interim valuation may get.

Speculative Bubbles use Rembrandt Valuation Models with the justification that this time, its different.

Common stocks sell partly as if theyre bonds with an uncertain coupon meaning theyre tied to economic reality. They partly sell based on a reasonable projection of the cash thats going to come out of them sooner or late. But partly they also sell like Rembrandts. They sell like a separate category that has gone up for a long time in the past which results in the creation of an investment fashion. And to the extent they sell like Rembrandts and more and more people purchase Rembrandts because buying Rembrandts worked for Rembrandt owners in the past, you get valuations that have no anchor in reality in terms of expectancies of future cash flows. Charlie Munger

Case: Samtel Color

Stock Price 15 Nov 01 to 14 Nov 11

Market Cap (Rs. Cr.)

NJHPS: Nathpa Jhakri Hydro Power Station is Indias Largest (1,500 MW) Hydro Electric Power Station

Sutlej River

A 62.5 meters high concrete Dam at Nathpa to divert water through four intakes

An underground De-silting Complex which is one of the largest underground complex for the generation of hydropower in the World.

A 27 km long Head Race Tunnel, which is one of the longest hydro power tunnels in the World

An underground Power House having six Francis Turbine Units of 250 MW each

Accountants ignore inflation, obsolescence, competition.

Maintenance Working Capital

Thank You