MENU

How does Warren Buffett Interpret financial statements.

For regular investors, understanding how Warren Buffett interprets financial statements is a great place to start when analysing what companies to invest in. While Warren Buffett’s exact interpretation of financial statements is unknown, he has given a number of key pointers over the years, with regards to what he looks for when investing in firms.

Income Statement

  • Gross Profit Margins: Buffett look for firms which have economic ‘Moats’ (Durable competitive advantages). Firms which are excellent performers in their respective industries tend to have much higher margins than their competitors.
  • Gross Profit Margins of over 40%. Conversely, firms which have gross margins less than 20% usually tend to sell products which are commodities or extremely price sensitive. These firms usually lack a durable competitive advantage.
  • Selling & General Administration expenses: Buffett aims to identify firms which spend less than 30% of their revenue on SG&A. This represents operational excellence and firms which tend to be best in class in their industries.
  • Return on equity: Buffett identifies this as being one of the most important measures of a firm’s ability to generate wealth for its shareholders over time. Buffett has regularly identified a 12% return on equity as being the average for public companies. Above 20% is good, while firms that earn above 30% are extraordinary.
  • Return on invested capital: Buffett identifies how management is reinvesting the firm’s retained earnings and how they are able to grow their earnings over time with funds earned in previous years. Firms earning more than 30% on re-invested capital are considered outstanding (reinvested capital are profits which the firm has earnt and directly reinvests into the business).
  • Net earnings: Consistent upward trend in the firm’s net earnings, with a consistency of performance over time and predictability in the firm’s earning power.

Balance Sheet

  • Debt levels: Buffett aims to identify firms with low levels of debt and is particularly wary of firms which have high-interest expenses. To Buffett, this may be a sign of a business that operates in a fiercely competitive industry or that the business is highly capital intensive
  • Cash balance: Buffett looks for an ample buffer of cash/marketable securities which ensures that the business will sail through economic downturns.
  • Inventories/Accounts receivable: Buffett identifies firms which increase their inventories and accounts receivable at the same pace which they increase their net earnings, demonstrating business efficiency.
  • Property & Plant: Buffett aims to identify firms which are not constantly required to upgrade their facilities and have a consistent spend on property/plant. Firms which have high capital expenditures tend not to have a competitive advantage.
  • Return on assets: Firms which generate high returns on their assets are demonstrating high levels of efficiency.

Takeaway for investors

The next time you try and analyse a business keep in mind some of the metrics that Warren Buffett looks for when analysing financial statements. Make sure that you are investing in companies which are best in class and have sustainable competitive advantages. Don’t make the mistake that most investors make of simply investing in average businesses.

‘Price is what you pay, value is what you get’  – Benjamin Graham

The Disruptors: 3 Revolutionary Aussie Companies to Back for 2018

We’re living in one of the most exciting times in investing history. Innovation and a booming culture of entrepreneurship are constantly creating new companies with the potential to make forward-thinking investors very rich. Now more than ever, one small, smart investment could make a huge difference to your wealth.

That’s why at The Motley Fool we’ve been scrutinizing the ASX to uncover the kinds of companies that we believe could turn into the next Cochlear or REA Group.

We’ve found three exciting companies that we believe re poised to perform in the new year. Click here to uncover these ideas!

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss a very important event! Chief Investment Advisor Scott Phillips and his team at Motley Fool Share Advisor are about to reveal their latest official stock recommendation. The premium “buy alert” will be unveiled to members and you can be among the first to act on the tip.

Don’t let this opportunity pass you by – this is your chance to get in early!

Simply enter your email now to find out how you can get instant access.

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our Financial Services Guide (FSG) for more information.