Suppose you are a believer in the philosophy of value or focus investing. In that case, you inherently understand that market prices don’t always equate to the intrinsic worth of a company. Thus, market prices often fall short as a reliable yardstick for assessing a company’s real-time performance. This begs the question, what, then, should be your golden benchmark? The answer is simple: Look-Through Earnings.

Dive into the mind of a legend, Robert Hagstrom, author of “The Warren Buffett Portfolio.” He introduces the concept of Look-Through Earnings in his insightful chapter titled “A Better Way to Measure Performance.” Get ready to redefine your investment strategy and join us on this thrilling journey into the world of value investing.

Deciphering Look-Through Earnings

“According to Buffett, since 1965 (the year Buffett took control of Berkshire Hathaway), the company’s look-through earnings have grown at an almost identical rate to the market value of its securities.”

• Robert Hagstrom

Coined by the master investor himself, Warren Buffett, Look-Through Earnings offer an unfiltered lens into a company’s genuine profit. It encompasses both retained earnings and dividends, presenting a more complete financial snapshot. Curious about the genesis of this concept? Read Berkshire Hathaway’s 1991 Chairman’s letter, where Buffett elucidates the term in-depth.

Buffett’s strategy transcends the boundaries of his own company, Berkshire Hathaway, as he strongly suggests that every investor should adopt a similar approach for their personal portfolio. Calculating your own look-through earnings will shift your focus from the short-lived market forecasts to the long-term business horizon. Because ultimately, in investing as in baseball, to rack up points on the scoreboard, your eyes need to be trained on the playing field and not the scoreboard.

Concocting Your Look-Through Earnings

Get your calculators out because the magic formula for look-through earnings is as straightforward as it gets:

([after-tax earnings] + [dividends]) = look-through earnings

Unveiling Owner Earnings: A Worthy Alternative

However, Look-Through Earnings don’t cover the complete canvas. Enter, Owner Earnings. Buffett designed this metric to calculate the profits one would amass if they were the sole owner of the company. This evaluation is made before any taxes and excludes expenses tied to business growth. If this sounds eerily similar to Free Cash Flow, you’re right, except for a tiny technical disparity.

Tracking the annual progression of owner earnings provides valuable insight into a company’s growth and overall health. I’ve found this to be a quintessential tool in business valuation. Here’s the formula I rely on:

[operating cash flow] + [tax provision] — [maintenance capital expenditures] = owner earnings

Crafting Your Benchmark

Armed with your favorite earnings calculation, it’s time to create your portfolio’s benchmark. It’s as simple as:

[owner earnings] / [total outstanding shares] = owner earnings per share

[owner earnings per share] * [# of shares you own] = your earnings

An Excel sheet can be a handy tool to manage and calculate these figures. The sum of the earnings for each company provides your portfolio earnings. The average owner earnings per share gives you the much-coveted benchmark.

Each company below the average requires a justification to stay in the portfolio. Each new company you are looking at purchasing can be compared to this benchmark and see if it will increase or decrease it.

In the Words of Charlie Munger

For an ordinary individual, the best thing you already have should be your measuring stick. If the new thing isn’t better than what you already know is available then it hasn’t met your threshold. This screens out 99 percent of what you see.

• Charlie Munger, Outstanding Investors Digest, August 10, 1955, p.10

This measurement stick is what we have been referring to as your benchmark.

Intrigued by this novel approach? Take a peek at the Google Sheets Owner Earnings Benchmark Template to aid you in your investment journey.

If this information has lit a spark in your investor spirit, let me know your thoughts, like, or comment below. For more investment wisdom, follow me on Instagram @kerryjonesinvestor.