Isn't the subtraction of deprecation and amortization redundant in the calculation of Owner's Earnings?

Question

I'm new to the world of Value Investing (and investing in general) and am trying to fully understand the fundamentals in calculating the Owner's Earnings of a company.

According to this blog, Owner's Earnings can be calculated as follows:

Owner Earnings =

(a) Net Income

+ (b) depreciation, amortization

+/- (b) other non cash charges

- (c) annual maintenance capex (or the full capex)

+/- changes in working capital

However, I can see in LVS' 2005 Annual Report (pg. 80) that the deprecation and amortization is already deducted in the calculation of the Net Income for the year. Is this typical in the reporting of Net Income? If so, then why are we deducting it twice in the calculation for Owner's Earnings?

Answer 1

This formula is not calculating "Earnings". Instead, it is calculating "Free Cash Flow from Operations".

As the original poster notes, the "Earnings" calculation subtracted out depreciation and amortization. The "Free Cash Flow from Operations" adds these values back, but for two different reasons:

• Depreciation is a non-cash charge. Depreciation is an estimate of the decline in value of an asset due to age, wear, and tear. But until/unless you decide you need to repair or replace the asset, depreciation does not require you to spend money out-of-pocket. (And even if you do spend money to repair or replace the asset, those costs appear elsewhere: repair costs are costs that have already been subtracted when calculating earnings, and replacement would be a capital expenditure.)
• Amortization of mortgage bonds does require cash out-of-pocket. This reduces your debt, so it is one way of using your free cash flow. In other words, the principal payments on your mortgage reduce your "Cash Flow from Financing Activities".