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Economic earnings represent the true earnings for shareholders and are very different from accounting earnings. GAAP accounting data was not originally designed for equity investors, but for debt investors.

To derive economic earnings, 30+ adjustments must be made to accounting earnings. These adjustments remove items hidden in the footnotes and MD&A of annual filings and close loopholes within GAAP accounting.

The formulae for economic earnings are in Figure 1.

Figure 1: How To Calculate Economic Earnings

NOPAT – WACC * Invested Capital

Or

(ROIC – WACC) * Invested Capital

Sources: New Constructs, LLC and company filings

Economic earnings are better than accounting earnings because

1. They are based on the complete set of financial information available
2. They are normalized for all companies
3. They are a more accurate representation of the true underlying cash flows of business.

If a company is not generating positive economic earnings, it is not creating shareholder value. Figure 2 shows which companies are creating and destroying the most value.

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