Earnings Power Value: A Reality Check on Rosy Forecasts

"Growth only creates value if returns on invested capital exceed the cost of capital — otherwise, growth destroys value." — Bruce Greenwald

Earnings Power Value (EPV) is Greenwald's antidote to over-optimistic forecasts. It values a business on its current, sustainable profit alone — assuming no growth — and then compares that to the value of its assets.

The calculation is straightforward: take sustainable operating profit after tax, and divide by the cost of capital. Then compare the result with the value of the company's assets:

• EPV below asset value — the business is earning poor returns on what it owns. It is destroying capital. Avoid.
• EPV above asset value — the business earns more than its assets would suggest. That excess points to a genuine franchise. Worth exploring.
• EPV roughly equal to assets — a fair business with no real edge.

The elegance is that EPV needs no heroic growth forecast. It tells you whether there is a real competitive advantage before you start paying for growth on top.

Illustrative example: WD-40 Company

The company's physical assets are modest, yet its earnings power far exceeds them — the result of an unusually strong brand and pricing power in its niche. That gap between earnings power and asset value is the signature of a franchise, which is exactly what EPV is designed to reveal.