Sorry if I'm missing something, but is your interpretation of owner's earnings correct? Dividends tend to come out of EPS (or retained earnings), so if you're adding the dividend back into EPS you'll be adding funds that don't actually exist.
Thanks for response, but I’m still confused. If you were to add the dividend to EPS, wouldn’t that give you an inflated number? An owner can’t earn more than EPS.
Thanks for the link, but I believe it just confirms what I was thinking. Unless if you are referring to preferred dividends, the metric doesn't agree with accounting rules.
As an example using the methodology in the infographic, let's say you have a services company that has no assets. They just have employees and they rent space, and they have no assets or retained earnings at the beginning of the year. At the end of the year, the company has produced $2,000 of net income. It pays out 75% of this, so the dividend is $1,500.
By the methodology in your infographic -
owner's earnings = EPS + dividend per share
or using aggregate numbers,
owner's earnings = net income + dividend,
the owner's earnings would be $3,500 (NI $2,000 + Div $1,500), but the owner didn't earn $3,500. The business itself only earned $2,000. In this instance, the owner can't earn more than what the business earned. This metric would be falsely adding an extra $1,500 that doesn't exist.
Sorry if I'm missing something, but is your interpretation of owner's earnings correct? Dividends tend to come out of EPS (or retained earnings), so if you're adding the dividend back into EPS you'll be adding funds that don't actually exist.
Hi Thomas,
Dividends don't impact the Net Income. They impact the Free Cash Flow. That's why I'm adding them again. :) I hope this helps!
Thanks for response, but I’m still confused. If you were to add the dividend to EPS, wouldn’t that give you an inflated number? An owner can’t earn more than EPS.
Hi Thomas,
I think this article will help you: https://www.investopedia.com/ask/answers/090415/are-dividends-considered-expense.asp
Let me know when this doesn't make it clear!
Thanks for the link, but I believe it just confirms what I was thinking. Unless if you are referring to preferred dividends, the metric doesn't agree with accounting rules.
As an example using the methodology in the infographic, let's say you have a services company that has no assets. They just have employees and they rent space, and they have no assets or retained earnings at the beginning of the year. At the end of the year, the company has produced $2,000 of net income. It pays out 75% of this, so the dividend is $1,500.
By the methodology in your infographic -
owner's earnings = EPS + dividend per share
or using aggregate numbers,
owner's earnings = net income + dividend,
the owner's earnings would be $3,500 (NI $2,000 + Div $1,500), but the owner didn't earn $3,500. The business itself only earned $2,000. In this instance, the owner can't earn more than what the business earned. This metric would be falsely adding an extra $1,500 that doesn't exist.
Hi Thomas,
Now I see the confusion. And maybe it's formulated a bit unfortunately in the visual.
The concept of Owner's Earnings is based on the approach of Warren Buffett and François Rochon. You can find more info here and I guess this will make everything clear: https://acquirersmultiple.com/2023/11/francois-rochon-owners-earnings-the-key-to-investing-success/
Oh ok, when you put it in growth terms rather than absolute terms it makes sense 100%. Thanks for getting back to me!