Tuesday, 30 April 2024
Monday, 29 April 2024
Great, Good and Gruesome Companies. Studying their financial statements.
?? INCOME STATEMENT:
1: Gross Margin
?? Equation: Gross Profit / Revenue
?? Rule: 40% or higher
?? Buffett's Logic: Signals the company isn’t competing on price.
2: SG&A Margin
?? Equation: SG&A Expense / Gross Profit
?? Rule: 30% or lower
?? Buffett's Logic: Wide-moat companies don’t need to spend a lot on overhead to operate.
3: R&D Margin
?? Equation: R&D Expense / Gross Profit
?? Rule: 30% or lower
?? Buffett's Logic: R&D expenses don't always create value for shareholders.
4: Depreciation Margin
?? Equation: Depreciation / Gross Profit
?? Rule: 10% or lower
?? Buffett's Logic: Buffett doesn't like businesses that need to invest in depreciating
asset to maintain their competitive advantage.
5: Interest Expense Margin
?? Equation: Interest Expense / Operating Income
?? Rule: 15% or lower
?? Buffett's Logic: Great businesses don’t need debt to finance themselves.
6: Income Tax Expenses
?? Equation: Taxes Paid / Pre-Tax Income
?? Rule: Current Corporate Tax Rate
?? Buffett's Logic: Great businesses are so profitable that they are forced to pay
their full tax load.
7: Net Margin (Profit Margin)
?? Equation: Net Income / Sales
?? Rule: 20% or higher
?? Buffett's Logic: Great companies convert 20% or more of their revenue into net income.
8: Earnings Per Share Growth
?? Equation: Year 2 EPS / Year 1 EPS
?? Rule: Positive & Growing
?? Buffett's Logic: Great companies increase profits every year.
? BALANCE SHEET:
9: Cash & Debt
?? Equation: Cash > Debt
?? Rule: More cash than debt
?? Buffett's Logic: Great companies don't need debt to fund themselves.
10: Cash & Debt
?? Equation: Cash > Debt
?? Rule: More cash than debt
?? Buffett's Logic: Great companies generate lots of cash without needing much debt.
11: Adjusted Debt to Equity
?? Equation: Total Liabilities / Shareholder Equity + Treasury Stock
?? Rule : < 0.80
?? Buffett's Logic: Great companies finance themselves with equity.
12: Preferred Stock
?? Rule: None
?? Buffett's Logic: Great companies don't need to fund themselves with preferred stock.
13: Retained Earnings
?? Equation: Year 1 / Year 2
?? Rule: Consistent growth
?? Buffett's Logic: Great companies grow retained earnings each year.
14: Treasury Stock
?? Rule: Exists
?? Buffett's Logic: Great companies repurchase their stock.
?? CASH FLOW STATEMENT:
15: Capex Margin
?? Equation: Capex / Net Income
?? Rule: <25%
?? Buffett's Logic: Great companies don't need much equipment to generate profits.
Caveats:
1?? There are plenty of exceptions to these rules.
2?? CONSISTENCY IS KEY!
Sunday, 28 April 2024
Multi-bagger or Falling knife.
"The best thing that happens to us is when a great company gets into temporary trouble .... We want to buy them when they are on the operating table."
Warren Buffett
(e.g. American Express)
"A stock that has fallen 90% is a stock that fell 80% first and then halved."
(e.g. Valiant bought and sold by Bill Ackman)
Reasons for steep falls
- Leveraged financials and loan/other losses.
- Food and other consumer products - safety, ingredients, etc.
- Victim of fraud
- Perpetrator of a fraud
- Unethical / Illegal behaviour
- Loss of key customer / product segment/ market
- Regulatory issues
Beware of COMMITMENT BIAS when you already own a stock.
This is a difference between the buying of American Express by Warren Buffett (putting 40% of his fund in this company) and not selling and buying more of Valiant by Bill Ackman. These are high risk, high return situations which can have extreme results (binary event).
Beware of LEVERAGED FINANCIALS
In banks, shareholders' money is 8% to 10% of its assets. 90% are borrowed money. A slight mistake can wipe out shareholders' money. Steep losses seen in bank, investors should avoid it like the plaque.
(e.g Deutch bank)
Food / Consumer brands - SPEED BUMPS?
Unintentional loss at the quality level that can be rectified. (eg, lead content in Maggi noodles of Nestle). These companies are not leveraged and usually bounds back in one or two years after taking a hit. These are buying opportunities. Speed bumps and not end of the road catastrophe.
Gangrene amputation pattern
Maybe alright to participate in the surviving business after the "bad segment" is disposed.
Drug companies involved in law suits due to side effects, generally avoid. Outcome is uncertain. If it is just technical or production issues, maybe an opportunity to own, as these are usually temporary and solvable.
Unethical / Illegal Behaviour
Wells Fargo beefed up its top and bottom lines through hard selling a few years ago. This unethical behaviour led to its stocks being hammered down. Is this a great company? Is the event a temporary threat to its business or a permanent life threatening catastrophe event to its existence?
B2B Quality / Other Issues
Foxconn workers committing suicide in China. Is this a temporary issue or is it a life threatening existential threat? This will guide you whether to buy or not.
Product quality issues. How many customers have run away? 1 customer or many / all customers.
Solution is product recall and replace. Example recall in cars due to certain defects. Temporary issue.
Additional notes:
September 2016
Warren Buffett in a Nutshell
https://www.facebook.com/photo/?fbid=8207395212659993&set=gm.10163476695514622&idorvanity=53286054621
What you look for in the financial statements of those great businesses with durable competitive advantage
Warren Buffett’s Financial Statement Rules of Thumb:
INCOME STATEMENT:1: Gross Margin
Equation: Gross Profit / Revenue
Buffett's Logic: Signals the company isn’t competing on price.2: SG&A Margin
Equation: SG&A Expense / Gross Profit
Rule: 30% or lower Buffett's Logic: Wide-moat companies don’t need to spend a lot on overhead to operate.3: R&D Margin
Equation: R&D Expense / Gross Profit Rule: 30% or lower Buffett's Logic: R&D expenses don't always create value for shareholders.4: Depreciation Margin
Equation: Depreciation / Gross Profit Rule: 10% or lower Buffett's Logic: Buffett doesn't like businesses that need to invest in depreciating assets to maintain their competitive advantage.5: Interest Expense Margin
Equation: Interest Expense / Operating Income Rule: 15% or lower Buffett's Logic: Great businesses don’t need debt to finance themselves.6: Income Tax Expenses
Equation: Taxes Paid / Pre-Tax Income Rule: Current Corporate Tax Rate Buffett's Logic: Great businesses are so profitable that they are forced to pay their full tax load.7: Net Margin (Profit Margin)
Equation: Net Income / Sales Rule: 20% or higher Buffett's Logic: Great companies convert 20% or more of their revenue into net income.8: Earnings Per Share Growth
Equation: Year 2 EPS / Year 1 EPS Rule: Positive & Growing Buffett's Logic: Great companies increase profits every year.
BALANCE SHEET:9: Cash & Debt
Equation: Cash > Debt Rule: More cash than debt Buffett's Logic: Great companies don't need debt to fund themselves.10: Cash & Debt
Equation: Cash > Debt Rule: More cash than debt Buffett's Logic: Great companies generate lots of cash without needing much debt.11: Adjusted Debt to Equity
Equation: Total Liabilities / Shareholder Equity + Treasury Stock Rule : < 0.80 Buffett's Logic: Great companies finance themselves with equity.12: Preferred Stock
Rule: None Buffett's Logic: Great companies don't need to fund themselves with preferred stock.13: Retained Earnings
Equation: Year 1 / Year 2 Rule: Consistent growth Buffett's Logic: Great companies grow retained earnings each year.14: Treasury Stock
Rule: Exists Buffett's Logic: Great companies repurchase their stock.
CASH FLOW STATEMENT:15: Capex Margin
Equation: Capex / Net Income Rule: <25% Buffett's Logic: Great companies don't need much equipment to generate profits.Caveats:
There are plenty of exceptions to these rules.
CONSISTENCY IS KEY!What "rules of thumb" do you use?
https://www.facebook.com/groups/53286054621/?hoisted_section_header_type=recently_seen&multi_permalinks=10163480421914622
"Warren Buffett and the Interpretation of Financial Statements" By Mary Buffett
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