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26 - Owner's Earnings: Why Net Income or EPS can be deceiving
Episode 26

26 - Owner's Earnings: Why Net Income or EPS can be deceiving

The DIY Investing Podcast · Trey Henninger: Private Investor, Portfolio Manager, Business Strategist, and Value Investing Expert

May 12, 201927m 4s

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Owner's Earnings - Show Outline

The full show notes for this episode are available at https://www.diyinvesting.org/Episode26

What is Net Income?
  • The total after-tax profits that a company earns in a year
What is EPS or Earnings per Share?
  • The After-Tax profits of a company divided by the total number of shares outstanding.
The problems with Net Income and EPS as a metric for investment
  • They are not comparable across different companies and industries.
  • Some companies are more capital intensive than others.
  • Net Income and EPS will overstate the economic "cash earnings" for capital intensive businesses that require large capital outlays on a regular basis.
Implications for the usefulness of P/E Ratios
  • Since P/E ratios are based on Net Income or Earnings per Share for the "E" component, they share the same problems.
  • P/E ratios are not comparable across industries or even companies within the same industry
Owner's Earnings - A better metric
  • Definition:
  • Owner's Earnings - Earnings that can be paid out in cash to shareholders without impacting the earning power of the business
How to calculate Owner's Earnings
  • Take Net Income and make some adjustments
  • Joshua Kennon's formula is the best that I have found. See link below in the references.
References:
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