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In my latest article, I justified the chronic cheap valuation of the oil companies by calculating the real earnings of these companies in the way that Warren Buffett does. According to Warren Buffett, the real earnings of a company, which he describes as "owners' earnings," are the reported earnings plus the depreciation (as it is not a real cash outflow) minus the capital expenses paid by the company only to maintain constant sales (he excludes the capital expenses used for growth).

In the case of the oil companies, the capital expenses have become so enormous in the last few years that they have greatly reduced the real earnings while they have not resulted in any production growth yet. This trend justifies the very low P/E that the market has consistently assigned to the oil companies in the last decade.

While this pattern seems very uniform for all the oil companies, many readers have asked me whether this formula changes significantly the earnings of other companies as well. Therefore, I applied Buffett's formula in 3 popular, premium companies: McDonald's (MCD), Wal-Mart (WMT) and Procter & Gamble (PG). As Wal-Mart reveals the exact numbers only for the US, I used the same ratio of expenses for growth to expenses for maintenance for the international sector of the company.

I tried to apply the formula on Coca-Cola (KO) too but the company does not disclose the percent of its capital expenses that is used for growth and hence it was not possible to apply the formula. However, in the last 3 years, the depreciation of Coca-Cola has been about 2/3 of its capital expenditures. Therefore, if one assumes that at least 1/3 of its capital expenses is used for growth, which seems reasonable given the pronounced growth of Coca-Cola, then the real earnings of the company are not lower than the reported ones.

The results for the other 3 companies are shown on the tables (all amounts in $B):

MCD

2008

2009

2010

2011

2012

Reported earnings

4.31

4.55

4.95

5.5

5.46

Depreciation

1.21

1.22

1.28

1.42

1.49

Capex for maintenance

1.24

1.14

1.17

1.54

1.71

Owners' earnings

4.28

4.63

5.06

5.38

5.24

% difference

-1%

2%

2%

-2%

-4%

Average

-1%

WMT

2008

2009

2010

2011

2012

Reported earnings

13.4

14.3

16.4

15.7

17

Depreciation

6.7

7.2

7.6

8.1

8.5

Capex for maintenance

7.5

5.8

6.4

6.8

6.5

Owners' earnings

12.7

15.8

17.7

17.0

19.1

% difference

-6%

10%

8%

9%

12%

Average

7%

PG

2008

2009

2010

2011

2012

2013

Reported earnings

12.1

13.4

12.7

11.8

10.8

11.3

Depreciation

3.2

3.1

3.1

2.8

3.2

3.0

Capex for maintenance

3.0

3.2

3.1

3.3

4.0

4

Owners' earnings

12.3

13.3

12.7

11.3

10

10.3

% difference

2%

-1%

0%

-4%

-7%

-9%

Average

-3%

It is evident from the tables that Buffett's formula has a much weaker effect on the earnings of the above companies than on those of the oil companies. On average, the earnings of McDonald's decreased by 1%, those of Wal-Mart increased by 7% and those of Procter & Gamble decreased by 3%.

The conclusion is that these premium companies need much less capital expense than the oil companies to maintain their sales constant. Moreover, it is always worth to calculate the real earnings of a company, as they may reveal early some changes in the business. For instance, Procter & Gamble has significantly raised its capital expenses in the last 2 years, thus causing a remarkable decrease in its real earnings. If the trend persists, it is something that its shareholders should take into account.

Source: What Are The Real Earnings Of These Premium Companies?