## What is Earnings Power Value?

**Earnings Power Value (EPV)** is a method used to estimate the intrinsic value of a stock under the implicit assumption that the current earnings and cost of capital are sustainable.

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## How Does the Earnings Power Value Work (EPV)

The earnings power value (EPV) measures the valuation of a company on a normalized basis, which is implied to be reflected by the earnings generated in the current period.

Bruce Greenwald, a professor at Columbia Business School widely recognized within the value investing community, is often credited for bringing the methodology to the general public.

However, the true origins of the EPV method, or at least the conceptual framework, trace its roots back to the teachings of Benjamin Graham and David Dodd.

**In simple terms, the earnings power value (EPV) states the fair value of a company is a function of the sustainability of its current earnings.**

Therefore, the EPV method is oriented around the core earnings power of a particular business, which refers to the sustainable level of current earnings on a normalized basis.

Conceptually, the earnings power value (EPV) answers, *“What is the fair value of the company if its current earnings power were to remain constant perpetually?”*

The core assumptions that underpin the earnings power value (EPV) method are as follows.

**Constant Size**→ No Forecasted Growth in Earnings (i.e. No Discretionary Spending on Working Capital or Fixed Asset)**Fixed Cost of Capital**→ Unchanging Minimum ”Hurdle Rate” to Invest (Risk-Return Trade-Off)

Graham and Dodd Earnings (Source: Value Investing: From Graham to Buffett and Beyond)

**Learn More →** Professor Greenwald EPV Lecture Slides (Source: Columbia Business School)

## How to Calculate Earnings Power Value (EPV)

The earnings power value (EPV) offers a conservative perspective on the intrinsic value of a company, without the necessity to explicitly project its near-term (or long-term) operating performance.

Of course, growth is a critical component to the sustainability of a business, particularly for crafting an economic moat to protect its long-term profitability.

However, growth is the most common cause of mishaps in judgment amongst value investors, which coincides with incurring steep monetary losses.

The decision to neglect the current earnings power of a company and instead prioritize the potential upside in growth can thereby be a costly mistake.

Why? The investor is paying more attention to the “potential” earnings on a forward-looking basis rather than its “actual” earnings.

The EPV is calculated as a company’s current earnings power divided by its cost of capital (WACC), which reflects the annual return expected by investors considering the risk-return profile on the investment.

The steps to calculate the implied valuation of a company under the earnings power value (EPV) are as follows:

- Step 1 → Retrieve Reported Net Revenue and Operating Income (EBIT)
- Step 2 → Calculate Average Operating Margin (3–5 Years)
- Step 3 → Apply Average Operating Margin to Sustainable Revenue (Current Period)
- Step 4 → Calculate NOPAT and Maintenance Capex
- Step 5 → Deduct NOPAT by the Excess Depreciation
- Step 6 → Divide the Adjusted Earnings by the Cost of Capital (WACC)