Business Valuation Fundamentals

Part one of a six-part series

Part 1 Meet Mesa Ridge

Why Investors Should Look Beyond the Numbers

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

• Capital allocation

  
  

More importantly, you'll understand how these concepts interact in real businesses.

Meet Mesa Ridge Concrete Company

Let me introduce you to Mesa Ridge Concrete Company, our fictional business.

• Location: Mid-sized metropolitan area in the Southwest

• Product: Ready-mix concrete delivered to construction sites within about a 30-mile radius

• Business Model: Buy sand, gravel, and cement → mix at the plant → load into trucks → deliver before hardening

  
  

What makes Mesa Ridge interesting isn't complexity—it's simplicity. The straightforward model lets us see business economics clearly, without getting lost in accounting complexity or industry jargon.

Mesa Ridge's Competitive Edge

• Exclusive sand pit ownership: The only sand pit within 100 miles

• Cost advantage: Sand is heavy and expensive to transport, so this gives Mesa Ridge a significant edge over competitors who must truck sand from farther away.

• Moat: While not insurmountable, this advantage creates a meaningful competitive barrier within the company's service area.

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Mesa Ridge's Financial Snapshot

Annual revenue	$10 million
Operating earnings (pre-adjustments)	$2.5 million
Invested capital	$10 million

That invested capital consists of:

• 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 Mesa Ridge Is the Perfect 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: Trucks depreciate on a straight-line basis in the books, but real economic value declines differently—key for understanding true earnings.

• Maintenance vs. growth capital: Mesa Ridge must replace trucks as they wear out, but what about upgrading to new fuel-efficient models? Is that maintenance or growth?

• Returns on incremental capital: The company earns 25% on its existing business, but what about expanding geographically? The answer reveals a critical concept most investors miss.

• Competitive advantages and their limits: The sand pit creates a real moat—but only within a certain radius. Knowing these boundaries is essential to proper valuation.

• Capital allocation: Should Mesa Ridge reinvest, acquire competitors, or return cash to owners? Each path has different implications.

  
  

Next Up

In the next post, we'll start with the foundation: why the financial statements don't tell you the complete story about Mesa Ridge's real economics. We'll explore the difference between accounting earnings and what Warren Buffett calls "owner earnings"—a measure of the actual cash a business generates for its owners. It's a simple concept, but it reveals economic realities that GAAP accounting often obscures.

From there, we'll build systematically: understanding returns on capital, evaluating reinvestment opportunities, analyzing competitive advantages, and ultimately, judging how well management allocates the cash the business generates. By staying with one example throughout, you'll see how these concepts connect.

Business analysis isn't about knowing a lot of isolated ideas—it's about understanding how everything fits together.