What Is Owner Earnings Run Rate?
Let me explain owner earnings run rate directly: it's an extrapolated estimate of an owner's earnings, which is essentially free cash flow, over a defined period, usually a year. You can think of it as projecting what the company will actually produce in dollars available to spend, based on its current financials.
Key Takeaways
This run rate gives you the expected dollar value a company will generate and have ready for use, drawing from its latest data. Remember, it assumes everything stays consistent, so don't apply it to businesses with irregular revenue patterns.
Understanding Owner Earnings Run Rate
To grasp this, you need to break it down into its parts: owner earnings and run rate. I'll start with run rate. It's a way to forecast future performance using past results. For instance, if a company made $100 million in revenue last quarter, you'd project $400 million for the year, calling that its run rate.
Now, owner earnings is a method Warren Buffett prefers for valuation. Net income gets a lot of hype, but it doesn't always show the real cash available to owners for distribution or value growth. Owner earnings aims to fix that. Buffett described it in his 1986 letter as reported earnings plus depreciation, depletion, amortization, and other non-cash charges, minus the average annual capitalized expenditures needed to maintain the business's position and volume, plus or minus working capital changes if required.
In simple terms, owner earnings equals reported earnings plus depreciation and amortization, adjusted for other non-cash items, minus average maintenance capex, and accounting for working capital shifts. This figure shows the value the company creates and how much flows to shareholders—it's often close to free cash flow, which is cash after operations and asset maintenance.
Advantages and Disadvantages of Owner Earnings Run Rate
You should use owner earnings to assess a company's financial health; rising owner earnings often signal strong future earnings, so an accurate run rate can help predict long-term performance.
But here's the issue: it's not always reliable because it assumes steady financials. Say a company has $9 million in owner earnings after three quarters—that projects to $12 million for the year at $3 million per quarter. This falls apart in seasonal industries where one period doesn't represent the whole.
Run rates also ignore spikes from new products, common in tech, or big one-time sales. They're flawed for companies with quarterly fluctuations.
Important Note
Keep this in mind: owner earnings run rate doesn't work well for businesses whose performance varies quarter to quarter.
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