Distributable Earnings

Distributable Earnings is the pot of gold at the end of the corporate rainbow. It represents the actual cash a business generates that could, in theory, be handed over to its owners (the shareholders) without harming the company's long-term operations. Think of it as the true profit. Unlike headline figures like Net Income, which can be clouded by accounting rules, distributable earnings get to the heart of the matter: how much cash is left after paying all the bills and, crucially, after spending the necessary amount to maintain the company’s current competitive position. For a value investing practitioner, this figure is far more insightful than what’s reported on the evening news. It reveals the genuine economic engine of a business, making it a cornerstone concept for investors like Warren Buffett who want to understand a company's real cash-generating power.

You might see a company report record-high earnings per share (EPS) and think it's swimming in cash. Not so fast! Standard accounting profit can be a bit of a mirage. It includes all sorts of non-cash expenses and doesn't clearly distinguish between money spent to grow the business and money spent just to keep the business from falling apart. Imagine you own a taxi company with one car. Your income statement might show a nice profit. But if your taxi is getting old and you need to spend €10,000 on a new engine just to keep it on the road, that's a real cash cost essential for survival. Distributable earnings accounts for this reality. It cuts through the accounting fog to show you the cash that is truly free and clear.

While there isn't one universally agreed-upon formula, the most common approach is logical and straightforward. It starts with the reported profit and adjusts it for non-cash items and essential capital spending. The basic formula looks like this: Distributable Earnings = Net Income + Depreciation & Amortization - Maintenance Capital Expenditures

This is your starting point, the “bottom line” figure you'll find on a company's income statement.

These are accounting quirks. A company buys a machine for €1 million, and its accountants “expense” a piece of that value each year (depreciation). But the company isn't actually writing a check for that depreciation expense; the cash is already long gone. So, to get to a cash figure, we add these non-cash charges back to the profit.

This is the secret sauce. Capital Expenditures (CapEx) is the money a company spends on physical assets like buildings, vehicles, and equipment. Maintenance CapEx is the portion of that spending required simply to maintain the company’s current level of operations—like replacing worn-out machines or fixing a leaky factory roof. This is a real cash outflow that must be spent for the business to survive, so we subtract it to find the true distributable profit.

Value investors obsess over distributable earnings because it answers the most important question: How much cash can this business provide its owners over the long term? This cash can be used for several shareholder-friendly actions:

• Pay dividends.
• Buy back company stock (also known as share buybacks).
• Pay down debt.
• Reinvest for growth (Growth Capital Expenditures).

This concept is nearly identical to what Warren Buffett calls Owner Earnings. The logic is the same: find the true cash flow available to the owners after ensuring the business's long-term health. A company that consistently generates high distributable earnings is a powerful cash-generating machine, the very thing a value investor dreams of finding.

Here’s the catch: companies don't break out “Maintenance CapEx” as a neat line item in their financial statements. Estimating it is more of an art than a science. Here are a few tips for getting a reasonable estimate:

• Read the Fine Print: Management often discusses their capital spending plans in the annual reports (like the 10-K filing in the U.S.). Look for clues that distinguish between spending for replacement versus spending for expansion.
• Use Depreciation as a Proxy: In a stable business that isn't growing, the amount spent on maintaining assets should be roughly equal to the amount those assets are depreciating. So, as a quick-and-dirty shortcut, you can use the depreciation figure as a proxy for Maintenance CapEx. Warning: This can be misleading for growing or shrinking companies, but it's a common starting point.
• Analyze the History: Look at a company's total CapEx over several years. If the business hasn't grown its sales or production capacity, it's likely that most of its historical CapEx was for maintenance.

Getting a precise number is difficult, but the exercise of trying to calculate distributable earnings forces you to think like a business owner, not a speculator. And that's a priceless perspective in the world of investing.