DEFINITION of Owner Earnings Run Rate
Owner earnings run rate is an extrapolated estimate of an owner's earnings (free cash flow) over a defined period of time (typically a year). This assumes that the firm's financial performance stays consistent throughout the period. Therefore, this estimate can be difficult to assess if the firm is operating in a business that experiences seasonality, because owner earnings from one period may not be applicable across the entire time period.
BREAKING DOWN Owner Earnings Run Rate
For example, after three quarters of performance, the company's owner earnings is $9 million. Assuming that performance stays consistent, the company's owner earnings run rate for the fiscal year would be $12 million ($3 million per quarter).
Owner earnings is often an important metric that investors can use to gauge a firm's financial health. Increased owner earnings tend to act as a signal that a company's subsequent earnings will be good. Therefore, assessing an accurate owner earnings run rate could be very important in predicting the company's longer-term performance.
More generally, run rate concept refers to the extrapolation of financial results into future periods. For example, a company could report to its investors that its sales in the latest quarter were $2,000,000, which translates into an annual run rate of $8,000,000.
Owner earnings is a valuation method detailed by Warren Buffett in 1986. He stated that the value of a company is simply the total of the net cash flows (owner earnings) expected to occur over the life of the business, minus any reinvestment of earnings.
From Buffet's 1986 Berkshire Hathaway Annual Shareholder Letter:
"If we think through these questions, we can gain some insights about what may be called "owner earnings. These represent (A) reported earnings plus (B) depreciation, depletion, amortization, and certain other non-cash charges such as Company N's items (1) and (4) 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. (If the business requires additional working capital to maintain its competitive position and unit volume, the increment also should be included in (C). However, businesses following the LIFO inventory method usually do not require additional working capital if unit volume does not change.)"