At the end of this post, you'll find a "Buy Now" button to purchase a 20-page report comparing Free Cash Flow to Warren Buffett's owner earnings. Though the two terms (free cash flow and owner earnings) are often used interchangeably, they are not always the same. Confusing the two can have a dramatic effect on your intrinsic value calculations.

This report:

gives an overview of free cash flow versus owner earnings;
thoroughly explains Buffett's definition and formula for calculating owner earnings;
walks the reader through a business - from start-up through Year 3 - to explain the financial statements;
looks at General Motors' free cash flow versus owner earnings and explains why the auto maker is suffering;
and more.

Before you pay the hefty $19.95 price tag, please note that this report assumes that the reader has, at the very least, a basic understanding of financial statements. To give you a better idea of whether or not you want / need to purchase and download this report, check out the first three pages for free.

Note: After purchasing the report, please be patient — it may take up to 24 hours to send it out. (I'm not tech savvy enough to figure out how to automate this stuff!)

Previous: Value Investing vs. Business Investing (Jul 10, 2008)
Next: Phil Fisher on Profit Margins, Part II (Jul 20, 2008)

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Comment on this [ 24 ]	By: Joe Ponzio

comments

Probably the best explanation I've ever read. It never really made sense until now. Definitely worth well more than $20. Thanks for the site and the report!

Tom H.

by Tom Howard on July 14, 2008 at 9:01 PM

Hi Joe,

Awesome!!!
Why?
It's another leap in my understanding! It's like a light bulb lighting up!

Regards,

Sanjay Shetty
I blog at http://indiainvestor.wordpress.com/

by Sanjay Shetty on July 15, 2008 at 10:06 AM

Wow, I think that would be great content for your book.

by Ben on July 15, 2008 at 11:28 AM

Very informative. Especially the last 6 pages!

by Adam on July 15, 2008 at 12:36 PM

This is an interesting idea to charge for certain longer articles. I would be interested to know if it is successful. It probably gives you more money than running Google ads.

My only concern is that if this material is going to appear later in your book. The book will probably cost around $20 total. But buying the book through these individual "blog" posts it could cost hundreds of dollars. It would be nice to get some clarification on if this will appear in the book. Also some lower pricing would be nice.

by Steve on July 16, 2008 at 12:14 AM

I don%u2019t think I%u2019ve ever had to pay for anything on this site before. I bought the report and I can tell you that it is AMAZING. It%u2019s worth much more than $20, especially if you factor in all the free information on this site.

My review:
This report is for people that need additional clarification on owner earnings. I thought I understood it until I read this report. Walking through a business from start to finish made it all make sense. Then, what I found most interesting is that Morningstar%u2019s free cash flow for GM was a positive $190 million but owner earnings was a negative $47 billion. That%u2019s a *huge* difference. GM%u2019s stock is down 60%, but anyone willing to invest $20 in this report would have avoided all of that (and saved much more than $20).

I hope Joe puts this in the book too but I remember a post where he said it wouldn%u2019t be available until next year. I didn%u2019t want to wait until then.

For all your work on this site Joe, I say keep it at $20. After having read the report, I can honestly say it is worth much more than that. If you do lower the price, consider my $20 a gift and a big THANK YOU!

by Michael Barrone on July 16, 2008 at 7:02 AM

Thanks, all, for the great feedback. It sounds like people are really enjoying the report.

Steve: I don't plan on charging for longer posts. This report is a 20-page explanation of owner earnings vs. free cash flow that took many hours to create over the course of a few days. The material, in some form, will be in the book as well; but, the book is not slated to hit the shelves until next year. If, as Michael Barrone said, you do not want to wait until next year, I personally think this report is well worth it (or I wouldn't sell it — you should see some of the crap peole ask me to sell on this site. I try to spare you guys the annoyances).

Everyone: This is not a chapter or section of the book that I ripped out and posted for purchase. As Steve mentioned — buying the book in 20-page pieces would cost hundreds of dollars. This is a special report and, though this material will be in the book (Adams Media, 2009), it is not ripped from the book or a substitute for the book.

I once told a visitor in an email that most of the book's information is freely available on this site. The book merely organizes and condenses (or expands on) it. To date, there are 145 blog posts, each averaging about three type-written pages. That's 435 pages of material, and we've got another year to go before the book comes out. The book won't be 435 pages long; so, this site is here partly to help expand on the book's contents. All said and done, a new reader of the book that decides to also read everything on this site is going to need a lot of coffee!

Do I think the report is worth $19.95? Perhaps I should have expanded in the post (and I will change it later), this report is for people that understand discounted cash flow but that are using free cash flow for every analysis. It offers insight into how a business' financials work for those who do not have the opportunity to run a business. I can tell you this: I wish I had something like this ten years ago.

To Those Whom Have Purchased The Report: Thanks so much. If I do lower the price in the upcoming weeks, I will certainly issue a refund for the difference. Best as I can tell, people seem fine with the $19.95 price tag; so, I don't expect to lower it. Still, if I do reduce the price, you will benefit as much as future purchasers.

by Joe Ponzio on July 16, 2008 at 8:52 AM

Hi joe
This is probably a simple question in the wrong area to post, i am planning on purchasing shares but do i go directly to the company or go for a stock broker. Im in the UK and want to mainly purchase US stocks, i dont know which stockbroker is good so any ideas, also the company im looking at is ExxonMobil (xom) they have a solid moat and i am doing valuation on it now.
thanks

by Kaf on July 16, 2008 at 12:15 PM

I have belonged to web investment sites that have charged fees, asked for donations, etc. Combined on these I have probably spent 100 times the cost of this article. I have probably learned 100 times more on fwallstreet than on all those other web sites combined. So $19.95 is a bargain. My only question Joe is why did you pick a price of $19.95 and not just $20?

by (MikeR) on July 16, 2008 at 12:24 PM

Kaf,

Since you are in the UK, you may want to check out opening a brokerage account with Interactive Brokers (IB). www.interactivebrokers.com

With IB you can select the currency you want for your account, US dollars, pounds, euros etc.. Also you can't beat the commissions.

I just got back from two weeks in the UK, one week in Scotland and one week in London. Awesome place.

by (MikeR) on July 16, 2008 at 12:29 PM

Kaf: Some companies have a direct purchase program (learn more by visiting their investor relations page). Or, you can open an account with a broker. I use a discount broker - TD Ameritrade.

(MikeR): I wanted to offer a big margin of safety :). Invest that saved nickle at 20% and you can have an extra $11.87 in 20 years. Compound it for 100 years, and your great grandkids can be sitting on $4.1 million. In all seriousness, I don't know why I chose $19.95. I think it's one of those things that immediately jumps out - sell it for x dollars and 95 or 99 cents. Or I could have gone the way of the gas pump and sold it for $19.998.

by Joe Ponzio on July 16, 2008 at 12:31 PM

Thanks guys

(MikeR), thanks, the UK is a nice place but i have yet to visit The US, hopefully in the near future.

Joe, thanks as well i had a look at the Uk branch of TD Ameritrade

by Kaf on July 16, 2008 at 4:39 PM

Joe,

I just finished going over the report for a second time, and I must commend you for a great effort and great result. Once again, you've provided a very straight forward approach. I admit, I had become a little too lax in my calculations for free cash flow. I never thought to really pore through all the non-cash charges that were being added back. I guess there really is a lot of stuff that can be omitted after all.

This has forced me to revisit all my prior intrinsic value calculations to come up with a more meaningful picture for each company.

Also, in regards to calculating maintenance capex, in order to come up with a nice average, I came across a way to do it in Bruce Greenwald's book, Value Investing. In there, he laid out a simple method (in some footnotes), which is as follows: "calculate the ratio of PPE to sales for each of the five prior years and find the average. We use this to indicate the dollars of PPE it takes to support each dollar of sales. We then multiply this ratio by the growth (or decrease) in sales dollars the company has achieved in the current year. The result of that calculation is growth capex. We then subtract it from total capex to arrive at maintenance capex."

This seemed to me to be a very straight-forward way to arrive at how much capex should be subtracted. The reason I mention it is because I'm interested in hearing your thoughts on it. Is there anything that I'm missing? What are the problems with it? Any feedback would be much appreciated.

Once again, thanks for the report. It will pay for itself soon enough.

by Nick on July 16, 2008 at 6:58 PM

I feel lucky, Joe sent me for free to review. I highly recommended this report as the free cash is THE ONE most important input to get the fair value of a stock. So it is definitely worthwhile investment.

by jay on July 16, 2008 at 10:08 PM

Joe,

Great write-up - this makes a lot more sense as a whole now. However, I have a question about "change in working capital" for the OE calculation. From what is the change in working capital derived? The report pinpointed it to one line for GM's cash flows sheet, but in looking at other companies, they don't have a similar line to refer to.

I noticed that MSN money has lists total changes in working capital, but I tried to reconcile these with the numbers from GM's annual reports and they are way off. So, my question is, how do I figure out what the correct "change in working capital" is for other companies?

Thanks!! Great article!!

Adam

by Adam on July 20, 2008 at 3:54 PM

Hi,
as soon as my paycheck arrives I'm going to buy this report, but until then I have one little question about Free Cash Flow calculation.

I'm from The Netherlands and here the annual company reports give the same things different names and that makes it very confusing for me to calculate the FCF of different businesses.

I have a lot of different forumula's for it which isn't making things easier ofcourse.

My question is if I use the following forumula:
FCF= Net income depreciation&amortization %u2013 changes in working capital %u2013 capital expenditures

And lets say the changes in working capital are -25million. Do I have to do:
FCF= Net income depreciation&amortization %u2013 25million %u2013 capital expenditures

or

FCF= Net income depreciation&amortization %u2013%u201325million %u2013 capital expenditures (here the double minus makes 25 million)

I would greatly appreciate it if someone could answer that little question, thanks in advance,

Nick

by NickFromHolland on July 22, 2008 at 2:45 PM

My entire post got scrambled :S Well let's try again:

My question is if I use the following forumula:
FCF= Net income depreciation & amortization - changes in working capital - capital expenditures

And lets say the changes in working capital are -25million. Do I have to do:
FCF= Net income depreciation&amortization - 25million - capital expenditures

or

FCF= Net income depreciation&amortization -- 25million - capital expenditures (here the double minus makes 25 million)

I would greatly appreciate it if someone could answer that little question, thanks in advance!

by NickFromHolland on July 22, 2008 at 2:50 PM

Joe,

I do follow your blog fairly regularly because I do think you have good information and find your posts informative. However, I have to say I'm concerned by your decision to start charging for your advice. I know this sounds strange and prior to internet blogging, the concept of providing free advice would have been outrageous, but the fact of the matter is that with the proliferation of internet blogs, advice is now essentially free.

For example, one could google owners earning calculation and find this information elsewhere for free. As far as why GM's FCF is misleading isn't it obvious? You tell everyone to read EDGAR and one quick scan would point out that FCF looks attractive in 2007 only because of GM's having to book a massive tax valuation allowance, which was a non-cash charge. Why the massive tax valuation allowance? because GAAP won't let you recognize an asset for future tax benefits when you need to turn a profit to recognize any future tax benefits!!! Something GM obviously can't do!

by BPal on July 23, 2008 at 12:59 PM

I don't see the problem...Joe decided to write a detailed paper on evaluation and Gm..He chose to charge for it. Either pay for it or don't. We live in a capatilistic society. Joe has been very VERY generous with his valuations on this blog, something that he never had to share to begin with.

So, I thank Joe that he only charged under $20 for the paper. You could buy worse investing books for more than that.

Just my 2 cents.
Dan

by Dan on July 23, 2008 at 2:35 PM

To all who may be wondering - this report is excellent and will return your investment many times over, if you are one who does your own stock valuations.

I've read many books about Warren Buffet, and nearly all the 'Buffet Partner Letters.' I've never seen anyone pull the valuation methods out of Buffet's words better than Joe does. Joe has truly deepened our understanding of value investing. And he has freely shared so much of this knowledge and specific examples on the website.

The report goes into great detail about Buffet's definition of Owner Earnings, and at 20 pages it is too much content to be just another web page.

By the way, Ittleson's book 'Financial Statements' - which Joe also recommends - is a great complement to the report. Put the two together and you will probably understand financial statements better than most on Wall Street.

by David
http://www.hybrid-car-show.com (my other hobby)

by David on July 23, 2008 at 6:27 PM

This report explains everything so detailed and in baby steps that everyone with a marginal experience in investing would be able to understand it! It was a great read and I took a lot of notes (and I only do that when I really think I've read something which is important to remember)

This report made so many things I was always in doubt about so much clearer for me. Financial statements now have a little less secrets for me :) Thank you so much Joe!

I'm now off to re-asses all my FCF valuations of companies I've made in the past haha! :)

by NickFromHolland on July 24, 2008 at 11:04 AM

Great report - more valuable than a bookshelf full of investing books. It's cleaverly written to anticipate and answer all your questions, and a real eye-opener.

F FCF!

by rob_h on July 25, 2008 at 8:40 AM

Hi Joe,

That was a well articulated and educational report. For confirmation purposes regarding the JNJ spreadsheet, would you replace the Free Cash Flow (FCF) numbers on the report with the Owner Earnings numbers? For instance, would it make sense to recalculate CROIC by changing the numerator to Owner Earnings from FCF? As well, instead of determining the FCF growth rate, would you calculate the Owner Earnings growth rate and then compare the Owner Earnings Growth rate to CROIC and thus determine the growth rate?

Thanks again for your continued support and generosity.

by Ryan B on July 30, 2008 at 9:05 PM

My friend purchased it with his credit card for me, and so far, I see how clever Joe's work remains, 20$ your generous!

by Amit D. on August 12, 2008 at 3:45 PM

Free Cash Flow vs. Owner Earnings

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