Owner Earnings Run Rate

You can break this one into two parts. You've got the "owner earnings" section and the "run rate" portion. We'll take the owner earnings part second, because that's the harder part, and we're being lazy.

So...run rate. It just takes a short section of time, and then projects outward what that would mean in a longer stretch of time. Like, if you run the first mile of a marathon in 12 minutes, that's a full-marathon run rate of about five hours and 15 minutes. It just takes your current pace and uses that to guess what your final total will be. For a company, if they have revenue of $100 million after a half a year, that's an annual run rate of $200 million.

Okay, now to the harder part. Owner earnings. We'll start with a fella named Warren Buffett. He looks and acts like your buffuddled grandpa. He's been 80-years-old for about 30 years now, and always seems like he's on the cusp of wandering away from a family picnic. He's also possibly the most respected investor of all time. He runs a company called Berkshire Hathaway, owner of things like Geico Insurance and Dairy Queen, and sits at number-three on the "richest person in the world list." Every year, he auctions off a lunch with himself to raise money for charity. In 2019, the winning bid paid $4.6 million. Just to talk to the dude over lunch. Point is: people respect what he has to say.

Well, in 1986, as part of a Berkshire Hathaway annual letter to shareholders, Buffett revealed that one of his favorite measures of a company's value is what he called "owner earnings." The actual equation for owner earnings gets a little complicated. You add reported earnings to non-cash charges (things like depreciation and amortization), then subtract what he described as "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." He then went on to provide some other subtleties.

Generally speaking, the figure is very similar to free cash flow. For some companies, the two numbers match exactly. Other times, they don't equal up. It depends on the situation.

The general gist behind owner earnings run rate is that an investment can be valued by the total amount of net cash flows it will generate over the course of its existence. The owner earnings run rate provides a basis for estimating that figure. With that, an investor can determine whether a venture is worth putting money into.