Meet Mesa Ridge Concrete: A Business Case Study in Investment Analysis
Most investors analyze businesses by reading financial statements and calculating ratios. Revenue growth? Check. P/E ratio? Check. Debt levels? Check. But this mechanical approach misses what actually matters: understanding the economics of the business itself.
Over this series, I'm going to use a single example—a concrete company—to walk through how I try to look past the financial statements and mechanical ratio calculations to understand what's really driving a business. By the end, you'll understand how to think about owner earnings, returns on capital, competitive advantages, and capital allocation. More importantly, you'll understand how these concepts interact in real businesses.
Let me introduce you to Mesa Ridge Concrete Company, our fictional business.
The Business
Mesa Ridge operates in a mid-sized metropolitan area in the Southwest. The company makes ready-mix concrete and delivers it to construction sites within about a 30-mile radius of its plant.
What makes Mesa Ridge interesting isn't complexity—it's simplicity. The business model is straightforward: buy sand, gravel, and cement; mix it at the plant; load it into trucks; deliver it before it hardens. But this simplicity lets us see business economics clearly, without getting lost in accounting complexity or industry jargon.
Here's what makes Mesa Ridge's position strong: the company owns the only sand pit within 100 miles. Sand is heavy and expensive to transport, so this gives Mesa Ridge a significant cost advantage over potential competitors who would need to truck sand in from farther away. It's not an insurmountable advantage—a competitor could still operate profitably—but it creates a meaningful competitive barrier (what investors call a "moat") within the company's service area.
The Numbers
Let's look at Mesa Ridge's basic financials:
Annual revenue: $10 million
Operating earnings: $2.5 million (before we make any adjustments)
Invested capital: $10 million
That invested capital consists of:
The sand pit: $3 million (book value)
Plant and equipment: $4.5 million
Truck fleet (20 trucks): $1.5 million
Working capital: $1 million
If you calculate return on invested capital mechanically, you get 25% ($2.5M ÷ $10M). That looks good on paper. But is it real? Can the company maintain it? Can it grow at those returns? These are the questions that matter, and the financial statements alone won't answer them.
Why This Business Works as a Teaching Example
Mesa Ridge will be our companion throughout this series because it demonstrates nearly every important concept in business valuation:
Real vs. accounting depreciation: Those concrete trucks depreciate on a straight-line basis in the company's books, but their real economic value declines differently—and that matters for understanding true earnings.
Maintenance vs. growth capital: Mesa Ridge must spend money replacing trucks as they wear out, but what about when new fuel-efficient trucks come to market? Is upgrading "maintenance" or not?
Returns on incremental capital: The company earns 25% on its existing business, but what returns could it earn if it expanded its geographic reach? The answer reveals a critical concept most investors miss.
Competitive advantages and their limits: That sand pit creates a real moat, but only within a certain radius. Understanding these boundaries is essential to valuing any business.
Capital allocation: What should Mesa Ridge do with the cash it generates? Reinvest? Acquire competitors? Return cash to owners? Each choice has different implications.
Why Financial Statements Don't Tell the Whole Story
If you pulled up Mesa Ridge Concrete's financial statements, you'd see operating earnings of $2.5 million on invested capital of $10 million—a 25% return that looks quite healthy. But that number is misleading, and understanding why gets to the heart of how to properly analyze any business.
The problem isn't that the accounting is wrong. The accountants are following the rules. The problem is that Generally Accepted Accounting Principles (GAAP) weren't designed to help you understand business economics—they were designed to create standardized, comparable financial statements. Those are different goals, and the difference matters enormously.
The Depreciation Problem
Let's start with Mesa Ridge's truck fleet. The company owns 20 concrete trucks with a book value of $1.5 million. In the financial statements, these trucks depreciate on a straight-line basis over 10 years. Simple, consistent, predictable: $150,000 in depreciation expense each year.
But here's the question: does a concrete truck actually lose value in a nice, smooth, predictable line over exactly 10 years?
Of course not. In reality:
Heavy use in the first few years causes faster value decline
A well-maintained truck might last 12-15 years
A poorly maintained truck might be worthless in 7
Market conditions affect resale value
Technological changes can make trucks obsolete before they wear out
The accounting depreciation of $150,000 per year is a guess—an averaging mechanism that makes financial statements comparable across companies. It's not meant to reflect the actual economic cost of using those trucks.
What This Means for Earnings
Mesa Ridge's $2.5 million in operating earnings includes that $150,000 depreciation expense. But what if the real economic depreciation—the actual decline in the fleet's value—is different? What if Mesa Ridge is running those trucks hard, getting only 8 years of useful life instead of 10?
You can't know the answer just from reading the financial statements. You have to understand the business itself.
But Wait—It Gets More Complicated
Depreciation is just the beginning. To truly understand Mesa Ridge's economics, we need to think about capital expenditures.
The company will need to replace those trucks eventually. Let's say the fleet originally cost $3 million and lasts 10 years on average. Simple math suggests $300,000 per year in replacement capital expenditures.
But what if:
New trucks cost more than old trucks (inflation, regulatory requirements)
Fuel-efficient trucks cost 25% more but become necessary to compete
The company needs to upgrade to GPS tracking systems to match competitors
Autonomous truck technology emerges and becomes the industry standard
Suddenly, the capital required to maintain Mesa Ridge's competitive position might be $550,000 per year, not $300,000. That extra $250,000 is real cash going out the door that the accounting depreciation doesn't capture.
This is why Warren Buffett created the concept of "owner earnings."
Owner Earnings: The Real Measure
In his 1986 letter to shareholders, Buffett defined owner earnings as: "Reported earnings plus depreciation, depletion, amortization, and certain other non-cash charges, less the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume."
Let's unpack that with Mesa Ridge:
Reported operating earnings: $2.5 million Add back:
Depreciation (non-cash charge): +$500,000 Subtract:
True maintenance capital expenditures: -$550,000 Owner earnings: $2.45 million
(Note: I'm simplifying here by using operating earnings. The full calculation would start with net income and make additional adjustments, but the principle is the same.)
That last item—"the average annual amount of capitalized expenditures...to fully maintain its long-term competitive position"—is the critical one. This isn't just replacing worn-out equipment. It's the capital needed to keep Mesa Ridge competitive with other concrete companies that are upgrading their fleets, improving their efficiency, and investing in technology.
Why This Matters
The difference between $2.5 million in reported earnings and $2.45 million in owner earnings might not seem huge—it's only 2%. But look what it does to our return calculation:
Using reported earnings: $2.5M ÷ $10M = 25% return
Using owner earnings: $2.45M ÷ $10M = 24.5% return
More importantly, we now understand what's really happening economically in this business. And this understanding becomes even more critical when we start thinking about growth and capital allocation.
The Questions You Should Ask
When you're analyzing any business, you need to ask:
What is true economic depreciation versus accounting depreciation?
What capital expenditures are required to maintain competitive position?
Is the business in a period of under-investment that's inflating current earnings?
Are there upcoming capital needs that aren't reflected in current spending?
The financial statements won't answer these questions directly. You have to understand the business, the industry, and the competitive dynamics.
What's Different About Owner Earnings
The beauty of owner earnings is that it forces you to think like a business owner, not an accountant. If you owned 100% of Mesa Ridge Concrete, you'd care about the actual cash you could take out of the business each year while keeping it competitive. That's owner earnings.
You wouldn't care that accounting rules say you depreciate trucks over 10 years if you know you actually need to replace them every 8 years. You wouldn't care that last year's capital expenditures were low if you know a major fleet upgrade is coming. You'd care about the economic reality.
This is the foundation for everything else we'll discuss. You can't properly evaluate returns on capital if you don't know the real earnings. You can't judge management's capital allocation if you don't know how much capital the business truly requires. You can't value a business if you don't understand its real cash generation.
