Scribd
Upload
22 views15 pages

Warren Buffett-1

Warren buffet guide investment strategy

Uploaded by

Rakotonindrina Baritiana
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
22 views15 pages

Warren Buffett-1

Warren buffet guide investment strategy

Uploaded by

Rakotonindrina Baritiana
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 15

INTRODUCTION

Warren Buffett, widely regarded as one of the greatest


investors of all time, has built his reputation by adhering
to a disciplined, long-term approach to investing. One of
the key components of his success is his deep
understanding of financial statements. Through careful
analysis, Buffett can determine the health, profitability,
and future potential of a business.

Buffett uses a few rules of thumb that uses when


analyzing a company’s financial statements. This guide
will break down these metrics, providing explanations,
formulas, and the reasoning behind them. By
understanding these key figures, investors can apply
Buffett’s principles to their own investment decisions.
INCOME STATEMENT
The Income Statement provides a summary of a
company’s revenues and expenses over a specific
period, usually a quarter or year. It tells investors how
much money the company earned (or lost) and what
costs were incurred to generate that revenue. Buffett
focuses on several key margins when evaluating the
income statement, which allows him to assess the
profitability and operational efficiency of a business.
GROSS MARGIN
Equation: Gross Profit ÷ Revenue
Threshold: Greater than 40%
Gross margin shows how much profit a company
makes after subtracting the cost of goods sold
(COGS) from total revenue. A high gross margin
means the company retains a significant portion of
revenue after covering direct costs, which is critical
for maintaining profitability. Buffett likes companies
with a gross margin above 40%, as it indicates they
have a competitive advantage, strong pricing power,
and control over production costs.

SG&A MARGIN (SELLING, GENERAL


& ADMINISTRATIVE)
Equation: SG&A ÷ Gross Profit
Threshold: Less than 30%
SG&A expenses include marketing, salaries, and
other overheads. Buffett prefers companies with low
SG&A margins because they demonstrate cost
discipline. A lower percentage of gross profit spent
on SG&A means more profits are retained.
Companies that spend less than 30% of their gross
profit on SG&A have a leaner operating structure and
more potential for profit growth.
R&D MARGIN (RESEARCH &
DEVELOPMENT)
Equation: R&D ÷ Gross Profit
Threshold: Less than 30%
R&D spending is critical for innovation, especially in
technology and pharmaceutical companies.
However, Buffett looks for companies that don’t
overextend on R&D relative to their gross profit. A
company that allocates less than 30% of its gross
profit to R&D is balancing innovation with profitability,
a sign of good management.

DEPRECIATION MARGIN
Equation: Depreciation ÷ Gross Profit
Threshold: Less than 10%
Depreciation reflects the allocation of costs over the
useful life of assets, such as machinery or buildings.
A low depreciation margin indicates that a
company’s fixed costs are not significantly reducing
its gross profit. Buffett looks for companies that
spend less than 10% of their gross profit on
depreciation, meaning that their assets don’t
consume too much cash over time.
INTEREST MARGIN
Equation: Interest ÷ Operating Income
Threshold: Less than 15%
Interest margin shows how much of a company’s
operating income is being spent on interest
payments. Buffett prefers companies that have low
levels of debt and, as a result, spend less than 15% of
their operating income on interest. High interest
payments can strain a company’s cash flow, making
it more vulnerable to economic downturns.

TAX MARGIN
Equation: Taxes ÷ Pre-Tax Income
Threshold: Equal to Corporate Tax Rate
The tax margin indicates how much of a company’s
pre-tax income is going to taxes. Buffett expects
companies to pay a tax rate that aligns with the
corporate tax rate, as this ensures they are not
relying on temporary tax loopholes or aggressive
accounting practices to boost profits. A company
with a tax margin close to the standard corporate
rate is generally more sustainable.
NET INCOME MARGIN
Equation: Net Income ÷ Revenue
Threshold: Greater than 20%
The net income margin measures a company’s
profitability after accounting for all expenses, taxes,
and interest. A high net income margin shows that a
company is not only generating revenue but also
efficiently converting that revenue into profit. Buffett
favors companies with a net income margin above
20%, as it indicates a high level of profitability and
operational efficiency.

EPS GROWTH (EARNINGS PER


SHARE)
Equation: Year 2 EPS ÷ Year 1 EPS
Threshold: Positive & Growing
EPS growth measures how much a company's
earnings per share have increased over time.
Positive and consistent EPS growth indicates that a
company is increasing its profitability on a per-share
basis, which is critical for shareholder value. Buffett
prefers companies with a track record of positive EPS
growth, as this shows their ability to grow earnings
year after year.
BALANCE SHEET
The Balance Sheet provides a snapshot of a
company’s financial position at a specific point in
time. It shows what the company owns (assets),
what it owes (liabilities), and the equity shareholders
have in the company. Buffett uses several balance
sheet ratios to evaluate the financial stability and risk
profile of a business.
CASH & DEBT
Equation: Cash ÷ Debt
Threshold: Cash > Debt
Buffett prefers companies that have more cash than
debt, as this shows financial strength and the ability
to weather economic downturns. Companies with a
high debt load are at risk of default during
challenging times, while companies with excess cash
have the flexibility to invest in growth opportunities.

ADJUSTED DEBT TO EQUITY


Equation: Total Liabilities ÷ Shareholder Equity +
Treasury Stock
Threshold: Below 0.80
The debt-to-equity ratio compares a company’s
total liabilities to its shareholder equity. Buffett
prefers companies with a ratio below 0.80, indicating
that the company has not overleveraged itself. A
lower ratio means the company has a stronger
balance sheet and is less reliant on debt to finance
its operations.
PREFERRED STOCK
Threshold: None
Buffett avoids companies with preferred stock.
Preferred stock often comes with fixed dividends and
senior claims to the company’s assets, which can
limit the upside potential for common shareholders.
Buffett likes companies that do not issue preferred
stock, as this ensures common shareholders retain
the most value.

RETAINED EARNINGS
Equation: Year 2 Retained Earnings ÷ Year 1
Retained Earnings
Threshold: Consistent Growth
Retained earnings represent the profits a company
keeps to reinvest in the business rather than paying
out as dividends. Consistent growth in retained
earnings shows that the company is generating
profits and reinvesting them for future growth, which
is a key component of Buffett’s long-term investment
philosophy.
TREASURY STOCK
Threshold: Exists
Treasury stock refers to shares that a company has
repurchased and holds in its own treasury. Buffett
views treasury stock favorably, as it shows that the
company believes its shares are undervalued and is
confident enough to buy them back. Companies that
engage in share buybacks often return value to
shareholders by reducing the number of shares
outstanding.
CASH FLOW STATEMENT
The Cash Flow Statement shows how cash moves in
and out of a business over a period of time. It breaks
down cash flow into three categories: operating,
investing, and financing activities. Buffett pays
particular attention to cash flow metrics, as they
provide insight into the true liquidity and operational
efficiency of a company.
CAPEX MARGIN
Equation: Capex ÷ Net Income
Threshold: Less than 25%
Capital expenditures (Capex) represent the money a
company spends to buy, maintain, or improve its
long-term assets. A low capex margin means that a
company is not overextending its cash flow on
capital investments, leaving more cash available for
other purposes, such as dividends or debt
repayment. Buffett prefers companies that spend
less than 25% of their net income on capex, as this
shows efficient use of capital.
CONCLUSION
Warren Buffett’s financial statement rules of thumb
offer investors a clear, practical framework for
analyzing companies. By focusing on key metrics
such as margins, debt levels, and earnings growth,
Buffett can identify companies with strong financial
health, operational efficiency, and long-term growth
potential. Investors who apply these principles can
improve their chances of making sound investment
decisions based on solid financial data.
FOLLOW ME
If you learned
something, please
spread the word by
liking or reposting this
piece
WWW.COMPOUNDINGQUALITY.NET

Pieter Slegers
Compounding Quality

You might also like

pFad - Phonifier reborn

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.

Note: This service is not intended for secure transactions such as banking, social media, email, or purchasing. Use at your own risk. We assume no liability whatsoever for broken pages.


Alternative Proxies:

Alternative Proxy

pFad Proxy

pFad v3 Proxy

pFad v4 Proxy