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Jonathan Goldberg

Earnings Power Value is an estimate of the value of a company from its ongoing operations. The beauty of Earnings Power Value, for value investors, is that the numbers used to calculate it are no growth free cash flows. No growth free cash flows just mean that we are only subtracting from cash flows the amount of capital expenditure required to sustain the business. By using no growth free cash flows we eliminate, to a great degree, attempts to predict future growth and as such arrive at a number which we can be fairly certain of; we are using today's earnings, with the assumption that current profitability is sustainable. This isn't to say that some companies can't expect significant growth, but as value investors we refuse to pay for it.

Though we are using today's earnings (today's no growth free cash flows) in calculating Earnings Power Value, we are normalizing these earnings to the business cycle. This eliminates the effects on profitability of valuing the firm at different points in the business cycle. Ideally, this means that we are considering the average operating profit (as a percentage of total sales) over 5-8 years. This average would then be applied to current sales. Other adjustments to be made to the current year's cash flows would be to account for average expected one-time gains/losses.

The final step in calculating Earnings Power Value is to divide the final cash flow number by the cost of capital. This gives us the present value of a perpetuity without any estimation of growth. That is the Earnings Power Value.

Difference between net asset value and Earnings Power Value

Unlike net asset value which is an equity value, the Earnings Power Value result is the enterprise value of the firm; that is, adjustments need to be made to trim this down to equity value.