“I could do this all year”

“Run-Rate Basis” is a technical finance term that has almost nothing to do with the individual words in the phrase. But no matter, it’s a trope that sounds really cool and that Wall Street people use to reinforce the notion that they are of above-average intelligence.

The phrase simply means to take a given metric such as revenue or profits for a recent period of performance, typically a quarter, and annualize the result (for a quarter, times the number by four). The purpose of doing this is to extrapolate recent past performance into the future. The potential problems with such fortune telling should be obvious.

Junior bankers, called analysts, are known to develop multiple techniques in their work to save time and energy. Anything that can shorten the period between when “face time” ends (typically 9 or 10 PM.) and when the analyst can actually get through his meaningless work and go home for the night is a welcome device. Using a “run-rate basis” is one such technique to make life easier, if used with caution.

For example, an inexperienced analyst trying to take a short-cut in his model might annualize the fourth quarter performance for Toys ‘R Us (Ticker TRU) to create a projection for the upcoming full year. Unbeknownst to our fledgling financial geek, the company is seasonal and derives three-quarters of its full year performance in the fourth quarter alone. Annualizing that number would make the next year’s revenue look, in comparison to last year, like a 1990’s internet stock.

A more appropriate use of this trick is when the analyst is working on a pitchbook at 2 AM and has no idea how to sort through a company’s “pro-forma” results when building a “comps” table.  A fudge in one or two lines of a comp table is not likely to be picked up by the “big picture” MD.

Managers of corporations also love to use this term when talking to Wall Street types for two reasons: 1) it reinforces the idea that they are all part of the same ‘smart-boys club’. Financial lingo helps the high finance players recognize other legitimate players on the field.  2) more importantly, managers like to use this method to hoodwink sleepy buy-siders into thinking that their current good fortune will go on uninterrupted.  Some have even been known to apply “run-rate basis” to just one month of results. We should all be so lucky to work for one month and have it count as a full year.