Why Michael Burry’s Big Tech Warning is Irrelevant to Value Investors Using Residual Cash Earnings

What is the “Depreciation Game” Michael Burry Exposed?

Michael Burry issued a stark warning that Big Tech “hyperscalers” are playing games with their earnings numbers.

The mechanism is simple:

1. Companies like Meta, Amazon, and Microsoft extended the useful life of their data center hardware and AI infrastructure, stretching the depreciation schedule from 3–5 years to 6–10 years or more (Barron’s reporting).

2. This is the “Magic Trick”: since depreciation is a non-cash expense that reduces reported profit, extending the schedule spreads the expense over more years. This lowers the annual cost, which in turn makes reported GAAP earnings look higher.

3. The Impact: This accounting change can boost reported profits by 20–30%, leading Wall Street analysts to celebrate “earnings beats,” even though the company’s actual cash position hasn’t changed at all (depreciation accounting primer).

As value investors, we see this for what it is: an accounting illusion. This 20–30% earnings boost is purely an accounting change, not an extra dollar of cash flowing into these businesses.

Michael Burry issued a stark warning that Big Tech “hyperscalers” are playing games with their earnings numbers.

Why is This Earnings Inflation Irrelevant to Value Investors?

This entire depreciation debate is irrelevant to sophisticated value investors because we don’t use accounting earnings to measure value.

For investors using the Residual Cash Earnings (RCE) framework, these accounting games are meaningless. RCE, developed by Greg Milano at Fortuna Advisors, is built to be immune to this manipulation (Milano, Postmodern Corporate Finance).

The reason is simple: RCE starts its calculation with EBITDA, which is earnings before interest, taxes, depreciation, and amortization. Depreciation is never subtracted, so it doesn’t matter if a server is depreciated over 3 years or 30 years—the starting cash earnings number is the same.

The Accounting Game vs. Cash Reality

This structured data table shows the impact of these accounting changes. Notice where the effect is zero.

Critical Insight: The RCE impact is zero across the board. RCE correctly recognizes that changing a depreciation schedule doesn’t change economic reality. Meta’s servers don’t suddenly generate more cash just because an accountant changed a number in a spreadsheet.

What is Residual Cash Earnings (RCE)?

Residual Cash Earnings (RCE) is an economic profit metric created by Greg Milano at Fortuna Advisors in 2009 (Fortuna Advisors’ founding).

Milano was a former partner at Stern Stewart & Co., the firm that created EVA (Economic Value Added) (Greg Milano biography). However, after years of implementation, he identified a critical flaw in EVA and other traditional return metrics (like ROE or ROIC): they actively discourage profitable growth investments (Milano, Beyond EVA).

The problem is that these metrics calculate returns against net book value—that is, assets after accumulated depreciation.

• This creates a “front-loaded cost problem” in which new assets (with a high net book value) make returns appear low.
• Old assets (which are almost fully depreciated and have a low net book value) make returns look artificially high.

This accounting artifact was causing real-world harm. Based on our analysis of this effect, managers using EVA were incentivized to turn down value-creating investments because doing so would temporarily reduce their reported returns.

RCE was designed to fix this flaw. It measures performance against gross (undepreciated) assets instead of net book value (Greene et al., Driving Outperformance).

Critical Insight: RCE was explicitly created to eliminate the growth-stifling bias of depreciation-based metrics. It ensures that a new, productive asset is measured on the same basis as an old one, focusing managers on creating cash value rather than managing an accounting denominator.

How Do You Calculate Residual Cash Earnings (RCE)?

The RCE framework is a four-step process designed to eliminate all depreciation assumptions.

1. Calculate Gross Cash Earnings (GCE): This starts with EBITDA (earnings before interest, taxes, depreciation, and amortization). From this, you subtract a tax provision. This figure represents the cash the business generates from operations before depreciation is recognized.

Formula: GCE = EBITDA – Tax Provision (Greene et al., Driving Outperformance)

2. Calculate Gross Operating Assets: Unlike traditional metrics, RCE uses gross assets at their original historical cost, with no depreciation subtracted. This maintains a stable capital base that doesn’t artificially decline over time.

Formula: Gross Operating Assets = Net Operating Assets + Accumulated Depreciation + Inflation Adjustments (Milano, Postmodern Corporate Finance)

3. Apply the Required Return (RR): the company’s weighted average cost of capital (WACC). This “capital charge” is applied to the full Gross Operating Assets.

Because it’s used to gross assets, this charge correctly captures both the return on capital (profit) and the return of capital (depreciation) (Greene et al., Driving Outperformance).

4. Calculate Residual Cash Earnings: The formula is elegantly simple. It’s just the cash generated minus the full cost of the capital required to create it.

Formula: RCE = Gross Cash Earnings – (Required Return × Gross Operating Assets) (Greene et al., Driving Outperformance)

Critical Insight: This design is the key. By adding depreciation back to both income (using EBITDA) and assets (using gross book value), RCE completely removes the depreciation distortion. The accounting choice becomes irrelevant.

How Does RCE Compare to EVA or CFROI?

As value-based management advisors, we’ve analyzed all primary economic profit metrics. RCE’s avoidance of depreciation estimates is its key structural advantage.

Milano’s empirical research confirms this. A study analyzing 20 industries from 1999–2018 found that RCE had a stronger correlation with Total Shareholder Returns (TSR) than EVA across all sectors (Milano, Beyond EVA).

Critical Insight: RCE is not just theoretically cleaner; it is empirically a better predictor of market value. It works because it strips away accounting noise and measures what the market ultimately values: real cash generation relative to the real capital deployed.

What Does RCE Reveal About Amazon’s AI Spending?

Amazon’s case in the 2010s is a perfect illustration of why RCE is superior for analyzing heavy investment.

While Amazon was building its massive AWS infrastructure, its GAAP earnings looked compressed due to enormous depreciation charges. But investors who understood the cash flow reality were rewarded.

Amazon 2018: GAAP vs. RCE Lens

• GAAP NOPAT (After Depreciation): $22.5 billion (Milano, Beyond EVA)
• Gross Cash Earnings (EBITDA-based): $58.0 billion (Milano, Beyond EVA)

The $35.5 billion difference was almost entirely depreciation. The RCE lens revealed that Amazon was creating massive economic value, even while reporting modest GAAP earnings. This fundamental value creation, hidden by GAAP, is what drove Amazon’s 1,400% share price appreciation during the 2010s (Amazon market performance).

Critical Insight: RCE forces the right question for today’s AI spending spree: Does this $200+ billion in infrastructure spending generate incremental cash flows that exceed the cost of capital on that gross investment? GAAP earnings, with their manipulated depreciation, can’t answer this. RCE can.

An Actionable Framework for Value Investors

As a Chief Investment Officer with nearly 40 years of experience, I’ve seen countless accounting fads. The current Big Tech depreciation game is just another distraction. My work focuses on separating accounting stories from cash reality.

GAAP investors are scrambling to debate “justification” and “estimates”. RCE investors shrug, because none of it matters to the cash flows.

Here is the strategic framework we use.

How Do You Calculate Residual Cash Earnings (RCE)?

The RCE framework is a four-step process designed to eliminate all depreciation assumptions.

1. Calculate Gross Cash Earnings (GCE): This starts with EBITDA (earnings before interest, taxes, depreciation, and amortization). From this, you subtract a tax provision. This figure represents the cash the business generates from operations before depreciation is recognized.

Formula: GCE = EBITDA – Tax Provision

2. Calculate Gross Operating Assets: Unlike traditional metrics, RCE uses gross assets at their original historical cost, with no depreciation subtracted. This maintains a stable capital base that doesn’t artificially decline over time.

Formula: Gross Operating Assets = Net Operating Assets + Accumulated Depreciation + Inflation Adjustments

3. Apply the Required Return (RR): the company’s weighted average cost of capital (WACC). This “capital charge” is applied to the full Gross Operating Assets. Because it’s used to gross assets, this charge correctly captures both the return on capital (profit) and the return of capital (depreciation).

4. Calculate Residual Cash Earnings: The formula is elegantly simple. It’s just the cash generated minus the full cost of the capital required to create it.

Formula: RCE = Gross Cash Earnings – (Required Return × Gross Operating Assets)

The takeaway is simple: Track the cash, not the accounting. That’s how serious investors separate real value creation from earnings manipulation.