Warren Buffett and the Analysis of Financial Statements

welcome to this video, we are going to discuss a book written by Mary Buffett, the ex-wife of Peter Buffett, the son of Warren Buffett, and by David Clarke, a Buffett scientist who took meticulous notes of master classes in Omaha, which is the Berkshire Hathaway's hometown. and Warren Buffett, this book was written to serve as a systematic and colorful guide to understanding how Warren Buffett makes stock investment decisions and to understanding the language of business, which is accounting. If you are looking for a guide to technical

analysis

or speculative investing, this is not the book or video for you.

I'm sure many viewers may know some accounting and also know how to read

financial

statements

, but in this video we're really going to focus on how and why Warren focuses on certain aspects of

financial

statements

.

analysis

and certain accounting concepts For anyone new to financial statement analysis, be prepared to watch this video more than once and also to consult other sources to complement your learnings. Accounting is the language of business and it is an imperfect language, but unless you are willing to do it. strive to learn accounting, which is how to read and interpret financial statements, you really shouldn't pick stocks yourself Warren Buffett, at its core, Warren Buffett's investing style is about improving on the methods of his mentor Benjamin Graham, the two themes What distinguishes Benjamin Graham's investment style is how to identify an exceptional company with a lasting competitive advantage and how to value a company with a lasting competitive advantage.

These companies own a piece of consumers' minds and therefore don't have to. change their product or service offerings and Warren Buffett developed a set of analytical tools to identify these special types of businesses: First they sell a unique product, these companies own a part of the consumers' mind and therefore can charge prices higher and sell more of your products. because you never have to change products, some examples include Budweiser Pepsi and Coca-Cola, they sell a unique service, companies that sell a unique service, our specific institutional, unlike specific people, do not have to spend a lot of money on redesigning the products nor do they.

They need to spend a lot of resources on building production or storage plants. Some examples include H&R, the tax company, and American Express, the credit card company. They are low-cost buyers and sellers of a product or service that the public constantly needs and enables. These companies earn higher margins than their competitors and remain low-cost sellers. What products or services? Examples of these types of companies include Walmart or Costco. These companies have monopolies as an economy that give them a long-term competitive advantage in addition to the underlying economics. of these businesses decreased their risk while increasing their gambling potential.

We know that his book is really about how Warren evaluates a company's financial statements, so he asked the following questions. Does it show consistent profits? Doesn't it have to constantly spend large sums on research and development show consistent profit growth have consistently high gross margins and consistently have little or no debt financial statements are what Warren Buffett cares about for companies with the golden enduring competitive advantage financial statements are a record of a company's financial activities financial statements tell you whether you are looking at a mediocre company or a company that has a lasting competitive advantage that will deliver exceptional returns the three key financial statements are the balance sheet the balance sheet results and the statement of cash flows the balance sheet is a statement of financial position, the balance that reports the company's resources or its assets, how these resources or its liabilities and shareholders' equity were financed on a particular date that could be at the end of a quarter or at the end of the year, so it's one point. estimate income statement illustrates the operating performance of a company is a statement of profit or loss over a specific period of time usually a quarter or a year along with the balance sheet and income statement cash flow statement is a financial statement required that provides information that the income statement cannot specifically tell us exactly how much cash a company generates and from what activities we also need to know where to find the financial statements and the book also gives us some instructions.

The Securities and Exchange Commission is a United States Securities and Exchange Commission. Federal agency established by the U.S. Congress in 1934 whose mission is to protect investors and maintain the integrity of the securities markets, including the establishment and maintenance of accounting principles and regulations for all public companies of the U.S. are required to file periodic reports with the SEC or the Securities and Exchange Commission only through the constant flow of timely, complete and accurate information, investors are able to make sound investment decisions and these filings can also be found at the FCC website, which is the government of the SEC, and for filings in other In some countries, there are some specific platforms that are similar to the SEC but a little less comprehensive and may also have a fee.

Examples include, for the UK, Companies House gov you K and Canada is sedar.com, plus you can usually find recent information. company presentations on company websites and usually found in the Investor Relations or Data Services sections, such as those that are free include Yahoo Finance or Google Finance and there are others with subscriptions including Capital IQ Thompson FactSet Bloomberg or Morningstar, the 10-k form, this is the main document for company data and at the end of each fiscal year, publicly traded companies must file a report called a 10k which is a detailed description of their business and includes their financial statements.

A 10k will typically contain details about financial information, such as stock options. fix and intangible assets, debt and future expectations and include extensive management discussions and analysis, also known as MDNA, the 10k also includes non-financial information, such as the strategic direction of the CEO, the president, the corporate profile, more mathematics and DNA or discussion, analysis and risk management. controlled processes and analysis and are generally submitted within 60 to 90 days of the end of the year at the end of each quarter of its fiscal year. Publicly traded companies also file a 10-q report that includes financial statements and non-financial data that typically has less detailed footnotes and MDNA than the 10k, the ten Qs must also be filed within 40 to 45 days. after the end of the quarter and you will often hear earnings calls that usually refer to the ten Qs.

There are other important presentations that companies must. file that includes the 8K or the 14a, which is a proxy or the 20F, etc., but the book doesn't go into any detail about that, so I won't cover it here. You have to read millions of corporate annual reports. in his financial statements Warren Buffett Warren begins his analysis with the income statement at a high level the income statement is income less expenses generated to equal profitability or loss it is very simple the income statement facilitates the analysis of the growth prospects of a company, the cost structure and the components and drivers of net profits the first line is the revenue or gross income to note that the source of profit is much more important than the income itself, not all income is income and Income alone doesn't tell us much either, so analyze what the company had to spend to obtain that income.

Expenses, also known as cost of goods sold or gear or cost of sales or cost of revenue for a service-based business, represent a company's direct manufacturing cost for manufacturers or procurement for merchants. having a good or service direct costs can include raw materials such as steel or wood a direct labor cost and factory overhead etc. It is very important to understand that gearing does not include administrative costs, this includes things like corporate marketing and administrative overhead. research and development and salaries of employees that are not directly associated with the product or service and these costs are generally included in these selling, general and administrative expenses or other items that we will discuss later, but still So they are gears.

Cost of goods sold alone doesn't tell us much either. Gross profit represents profit only after direct gear expenses have been subtracted from income. The gross profit margin tells Lauren about the economics of the company. Companies that have lasting competitiveness. advantage have consistently higher gross margins and generally companies with a gross profit margin of 40% or more have some type of lasting competitive advantage if it were that simple, after considering gross profit margins we have other expenses commonly known as operating expenses and these are indirect operating expenses that include things like SGA, precision and development or Rd, depreciation and amortization and primary charges etc.

Warren examines these operating expenses very carefully. SG&A, our operating expenses that are not directly associated with the production or acquisition of the product or service that the company sells to generate income, so this includes things like management salaries, payroll salaries, commission meals and travel expenses , stationery, advertising and marketing expenses Warren looks for companies with consistently low SGA spending as a percentage of gross profit. SGA spending below 30% is Good companies that do not have a durable competitive advantage have wide variations in their overall SGA Warren stays away from companies with high SGA expenses Warren also stays away from companies with high SGA expenses of R&D R&D The activities of our company that are aimed at the development of new products or procedures, the competitive advantage for companies with high R&D expenses is generally due to a patent, our technological advance, which means that when the patent disappears, the competitive advantage also disappears, as in the case of many pharmaceutical or technology companies, for example, a brand that is a pharmaceutical brand.

The company spends approximately 30% of its gross profit on R&D and 49% on sgna for a total of 78 percent of its gross profit on these operating expenses. This is a little difficult to accept, but Warren believes that companies that have to spend so much on these indirect operating costs have an inherent flaw in their competitive competitive advantage and their long-term economics. You must have heard of the acronym EBIT e beta is earnings before interest taxes, depreciation and amortization, which is the gross profit subtracted by SGA and RD is subtracted, EBIT is a popular measure of financial performance from a company that Warren doesn't like because he believes that depreciation and amortization are very real expenses that we will look at next.

All machines and buildings have a finite useful life and must eventually be replaced due to depreciation and amortization. It is the systematic allocation of the cost of a fixed asset over its estimated useful life and there is more than one method of calculating depreciation, but I will give an example using the straight line method, for example, a magazine company purchases a printer for $100,000 with a useful life of ten years and a scrap value of $1,000, what is the depreciation expense that the company reports in its income statement each year? The depreciation expense is calculated by taking the purchase price of $100,000 subtracting the scrap value. which is $1,000 and dividing the difference by ten years gives us a depreciation expense of ninety nine hundred dollars per year, all this means that the total expense of the printer is not taken in the year in which it is purchased, but is allocated in increments of ninety nine hundred dollars over ten years.

Warren believes that depreciation should always be used in calculating profits Warren favors companies with depreciation expenses less than ten percent of gross profit Interest expense is the amount the company has to pay on the debt it owes carried on the balance sheet as a liability, these could be bondholders or for banks, however sometimes the company could have earned interest income, such as a company's income from its cash holdings and investments in stocks, bonds and savings accounts, interest expenses are a financing cost and not an operating expense because they reflect the debt a company has and So, what does Warren think about interest expenses?

Companies with a durable, long-term competitive advantage have little or no interest expense. TheTypical interest expense ratios vary depending on the industry, so you'll have to do your homework on this. The authors gave an important example in the 2006 book, an investment company called Bear Stearns reported that it paid 70% of its operating income in interest payments and in November 2007 that figure increased to 230 percent. The company went from $170 per share to $10 per share when it merged with JPMorgan. Chase & Company companies are also required to report infrequent income and expenses, such as gains or losses, and could be from the sale of an asset other than inventory or the disposition of a business segment.

A gain is the difference between the proceeds of the sale and the carrying value on the company's books. This other item could be things like licensing agreements, the sale of patents, impairment charges, cancellations or restructuring costs, these Unusual or infrequent items present a challenge when we do financial statement analysis because management teams may decide how to classify operating items or they may not clearly label unusual or infrequent items and that means these other expenses could be shown as separate items on the income statement if their material, such as the gain on an asset sale, or could be buried within unusual figures of net earnings to get a truer picture of what is happening in the company.

Earnings Before Tax or EBT is an important number to use to compare different investments Warren analyzes a company's earnings in pre-tax terms, for this reason the average income tax for a corporation is around 35% in the United States, so looking at the amount of income tax paid is a great way to see if a company is actually making money and claims that all we have to do is take the pre-tax earnings, the EBT, and add F 35% if the tax paid on the income statement is very different, start asking questions, net income is an important indicator for a company. with a lasting competitive advantage one ratio to consider is net income divided by total income the higher the percentage the better because it can tell us a lot about the economics of the business compared to other businesses a low ratio between net income and total income can mean that the company is in a highly competitive industry.

Warren's rule of thumb is to look for a 20% ratio of net income to total income. Earnings per share are net income divided by shares outstanding. However, it is not enough to take earnings per share over 1 year. Warren analyzes earnings per share over a 10-year period to see if a company has a lasting competitive advantage. The 10-year trend must be upward and there must be consistent erratic changes. Booms and busts create an illusion of buying opportunities Be careful one of the things you will find that is interesting and that people don't think about enough is most companies and most people, this Life tends to bite you at your weakest link, the two weakest links I have seen in my experience. more people fail due to alcohol and leverage, leverage, borrowed money Warren Buffett, the balance sheet shows the resources of a company, what its assets are and how those resources were financed, what the liabilities and shareholders' equity are at a date In particular, what the end of the year might be, for example, think of the balance sheet as a point estimate or a snapshot of a moment in time.

This is the famous accounting equation: assets equal liabilities plus shareholders' equity and it is a balance sheet because it needs to balance. That's why we do double entry. Accounting when developing a balance sheet, the author did not review it in the book, so I will leave it out as well. There are many different types of assets which are divided into current assets which means they can be converted into cash within 12 months or non-current assets which would take over a year current assets can be converted into cash quite easily within an hour Things like cash and marketable securities accounts receivable inventories and prepaid expenses these are listed on the balance sheet in order of liquidity, so the most liquid assets to the least current are also known as working assets because they illustrate the cash cycle of cash inventories and accounts receivable.

Look for companies where inventory and cash grow together, cash or cash equivalent, such as three-month Treasury bills or a short. Term cash deposits are highly liquid assets. Lots of cash can mean that the company is generating cash through its businesses or that it recently sold a business unit or social bonds, for example, long-term profits on current assets cannot be converted into cash during the year. There are things like long-term investments, property, plant and equipment, tangible assets and goodwill. Non-physical assets, such as patents, trademarks, and goodwill, are acquired by the company and have a value based on the rights owned by that company.

One important thing to note is that most balance sheet items are presented at their historical or actual acquisition cost, known as their book value. This prevents assets from being overstated and is an example of conservatism. Cash or cash equivalents, such as 3-month Treasury bills or short-term certificates of deposit, are highly liquid assets, since a lot of cash has already been discussed, it can mean that the company is generating capture business or which recently sold a business unit. Companies use excess cash to expand their business operations. They acquire new companies. They invest in shares of other companies to be able to buy back their shares or pay in cash. dividends to their shareholders or they can even save it.

The three basic ways to create a large cash reserve are to sell new corporate bonds or issue shares to the public to sell an existing business or asset or three to generate excess cash through your ongoing business when Warren analyzes the business with excess cash and little debt. He is betting that the company can withstand any short-term problems, but only if it sees it generate cash through its ongoing business operations, so as a reminder, current assets are assets that are expected to be converted. in cash in less than one year current liability is any amount that must be paid to a creditor in less than one year a non-current asset is any asset that is expected to be held for more than one year any non-current liability is any obligation that is not owed be paid within a year and we will discuss any liabilities that arise.

Current ratios measure a company's ability to meet short-term financing needs, and the current ratio is equal to current assets divided by current liabilities, a rule of thumb. As a general rule, a current ratio greater than one is considered good, implying that there are more liquid assets than short-term liabilities, which reflected a healthier level of liquidity; However, many companies with enduring competitiveness may have a current ratio less than one. It is because of their large purchasing power that they can pay dividends and buy back their shares, which can reduce their cash reserves and decrease their current ratio, so be aware that Warren is not a fan of PG&E, no PG&E purchases or expenses of capital. that decrease cash, PP&E or property, plant and equipment represents land, buildings and machinery used in the manufacture of the company's services and products plus all costs that may include the transportation facility, etc., necessary to prepare those fixed assets for service, PP&E cycles go out of balance. sheet and on the income statement as depreciation, whether on the gears or the sgna or elsewhere, so when a company does not have a long-term competitive advantage, it usually has to make capital expenditures to remain competitive in their industry and generally have to access debt financing to repay companies that acquire other companies.

Goodwill can become a considerable asset on the balance sheet. Goodwill is the amount by which the purchase price of a company company exceeds its fair market value which represents the intangible value arising from the acquired company's trade name customer relationships employee morale and product potential goodwill is created only if the purchase price exceeds the book value of all assets acquired and sometimes, if the value of a previously acquired company decreases, goodwill is recorded as an impairment charge on the balance sheet. Amortizations of goodwill imply that a company overpaid and in the original acquisition, this is an example: Gilead acquires Pharma in 2011 for 11 billion US dollars, the book value of the pharmaceutical group was 172 million US dollars in 2011, Gilead believed that due to the market potential of Phobia it was enough to treat The fair market value of Hepatitis C Pharmacists is much higher and therefore it is very likely that they will acquire or negotiate to acquire Pharma for 11 billion dollars, which is between ten point eight and eight thousand million above the book value of the pharmaceutical group and who paid between ten point eight and eight billion. above book value is recorded as goodwill on Gilead's balance sheet.

Intangible assets are made up of non-physical acquired assets, meaning the asset must be acquired and not developed internally and types of intangible assets may include customer lists, franchises, memberships, licenses, technology patents and trademarks, copyrights, author and Intangible goodwill assets are reduced on the balance sheet through an amortization expense on the income statement. The Coca Cola brand is worth billions but it is not recorded on the balance sheet because it was developed internally, so remember that these companies with a lasting competitive advantage often have their biggest asset absent from their balance sheet, their brand is worth billions because many millions are addicted to sugar, but that is for another day and that is why we need to ensure that the company is making efficient use of its assets, which is why we calculate the return on total assets.

Return on total assets is net earnings divided by total assets at the time of this writing. Coca-Cola had forty-three million dollars in assets and a return on total assets of 12%. Moody's had $1.7 billion in assets and a return. on total assets of 43 percent, so Warren argued that it would be much easier to raise $1.7 billion to acquire Moody's versus $43 billion to acquire Coca-Cola. The durability of Moody's competitive advantage is much weaker than Coca-Cola's because of the lower cost of entry into the business, although remember the accounting equation that assets must equal liabilities plus stockholders' equity, liabilities too They are divided into current liabilities, as we mentioned above, which are less than a year old and non-current liabilities that must be repaid. after one year, which is similar to current and non-current assets, simply put, liabilities and stockholders' equity represent the company's sources of funds, which is how it pays for its assets, liabilities represent what the company owes to others and must be measurable and its occurrence is probable and capital represents sources of funds through capital investments and retained earnings retained earnings are what the company has earned through operations since it began liabilities current include accounts payable accrued expenses, for example, short-term employee salaries term debt due in 12 months and its deferred revenue and long-term or non-current liabilities include long-term debt or capital leases debt to long-term simply is whose maturity exceeds 12 months and shareholders or owner's capital encourage preferred stock common stock treasury retained earnings from stock and other comprehensive income that includes foreign currency translation gains and losses or unrealized gains on available securities for sale, etc., so that any change in assets or liabilities or in stockholders' equity is accompanied by a compensating change that maintains the balance sheet.

Well balanced on the balance sheet, liabilities are presented in the order of when they are due to be paid, so liabilities such as short-term debt and accounts payable must be paid within 12 months and any part of the long-term debt that matures within 12 months. The year also appears in the short-term debt items, long-term liabilities, such asLong-term debt is not included within the year and can also be a considerable liability, so be warned to carefully examine how much short-term and long-term a company has. He avoided companies with a higher proportion of short-term debt than long-term debt. Companies with a durable competitive advantage require little or no long-term debt.

They finance themselves with their commercial operations. Warren reviews how much long-term debt they have. have had over the last ten years companies with a durable competitive advantage have enough profits to pay off all their long-term debt within three or four years a minority interest is the ownership or interest of less than fifty percent of a company, but this The term can refer to ownership of shares or partnership interests in a company, so minority interests are the part of a company or shares that is not held by the parent company that has a controlling interest, the majority of interests Minorities range between twenty and thirty percent and appear as a liability.

On the balance sheet, this item doesn't do much to identify a company with a lasting competitive advantage, but it's still important to know what this item means. Solvency ratios are measures of a company's ability to pay its debt obligations. Debt-to-equity ratios help identify what debt our company is using to finance its operations. The debt-to-equity ratio is total liabilities divided by shareholders' equity, so we would like to see a company with high shareholders' equity and low total liabilities, but sometimes this ratio can be misleading, for example, a company with a durable competitive advantage could be buying back shares, which would effectively reduce its shareholders' equity because it is using its retained earnings and increasing the debt-to-equity ratio that the collateral prefers to add back into any Treasury. shares that the company acquired through share buybacks before calculating this ratio.

A company with a debt-to-equity ratio of 0.65 means that for every dollar of equity the company has sixty-five cents, and a ratio of 38 means that for every dollar of equity the company has sixty-five cents. the company has $38 of debt rearranging the accounting equation assets minus liabilities equals shareholders and equity represents sources of funds through equity investments you want preferred stock common stock or treasury stock and retained earnings so let's review each of these types of shares in detail the first time you own preferred shares preferred shares or shares that have special rights to a dividend that have priority over owners of common shares and do not have voting rights Companies with a durable competitive advantage do not tend to have preferred shares because they have little debt, which means that their self-financing and also the dividends that are paid are not deductible, like the interest on debt, which really makes this money expensive.

Put another way, most companies do not issue preferred stock because it is considered tax-disadvantaged debt and dividends do not reduce taxes. income then you have common shares common shares represent capital received by a company when it issues shares, so it allows participation in the company's profits in the form of dividends, it also represents ownership and voting rights, so a vote is for each share it owns and if a company is dissolved, any residual amount after everyone else is paid would go to the common shareholders, then come treasury shares, this is what a company buys back its common shares, the company can cancel them or hold them with the possibility of reissuing the shares later, which is what we call a treasury share, so companies that have a lasting competitive advantage have treasury shares or have repurchased their shares and finally we have retained earnings.

The company's net profits may be retained, may be used to pay dividends, or may be used for buybacks. Warren's shares retain 100% of Berkshire Hathaway's net or retained earnings are a cumulative number of all previous years and if the company does not increase its retained earnings it is not increasing its net worth, so if the rate of the A company's retained earnings is a good indicator that the company is benefiting from its enduring competitive advantage and a company can increase its retained earnings from its business operations or by acquiring other good businesses and Warren himself would use its earnings retained companies to acquire other companies to increase retained earnings but it also has to continue buying other companies with a durable competitive advantage and that is how Warren has converted his billions into a return on equity ratio if net income is divided by the total capital, so when a company buys back its shares and retains the shares. such as Treasury shares, reduces shareholders' equity but effectively increases return on equity, such as when a company reports a high return on equity, look for evidence of financial engineering, such as the presence of Treasury shares, or if there is actually an excellent business economics, a company with The durable competitive advantage they had tends to have excellent return on equity ratios and, over time, this value is reflected through an increase in the company's stock price and, if you remember , we talked about return on total assets, one of the main challenges with return on equity.

Total assets is that it combines a measure of leveraged profitability with a measure of unleveraged assets. Remember that assets can be financed with or without leverage and net income is sensitive to leverage because we deduct interest expenses, therefore the return on total assets is not the best. ratio to use when comparing different companies with slightly different leverage ratios, so return on equity solves this challenge by factoring leverage into the denominator and calculating the return only on the company's equity value, making it easier to analysis between companies with different degrees of leverage Essentially, return on equity is a test of management's efficiency in allocating money to shareholders;

There is a big difference between the business that grows and requires a lot of capital to do it and the business that grows and requires no capital. The final financial statement that we will talk about is the cash flow statement, if you remember we said earlier. Warren believes cash is king. The cash flow statement provides information that the income statement cannot because it tells us exactly how much cash a company has. Accrual accounting is one of the most important concepts in accounting and governs the company's timing and recording of its revenues and associated expenses, so revenue recognition is actually an accrual basis of accounting that dictates that revenues They must be recorded when they are obtained and measurable, on the other hand, the principle of comparison is that the costs associated with the manufacture of a product must be recorded during the same period as the revenue generated from that product, so, although good accounting has its benefits, in a way it makes it difficult to objectively track the movement of cash, only the income statement or balance sheet and therefore we need a cash flow statement.

The cash flow statement effectively reconciles net income with a company's actual change in cash from the beginning balance. cash transactions and the ending cash balance over a period of time, such as a quarter or a year, so, along with the balance sheet and income statement, the cash flow statement is a required financial statement and provides the idea that the income statement cannot be realized. It tells us exactly how much cash a company generates and from what activities, and cash transactions are classified by type of activity. This is broken down into three sections, cash from operations which is how much cash the company generated from operations during that period and uses net income as a starting point and converts accrual based net income into cash flow of operations through a series of adjustments, but only cashless and accruals, then we have cash coming from investing activities and this could be capital expenditures or sales and purchases of assets and Finally we have cash financing coming from financing activities which could be new loans or debt repayment, any new issuance of shares or share buybacks and the issuance of dividends, net income is the starting point of the cash flow statement and when something called the indirect method is used.

What we won't go into on the next line in a cash flow statement is adding back the non-cash depreciation and amortization expenses that are included in the cost of goods sold and operating expenses on the income statement, thus reducing income. net and just a retrospective of the income statement to see that amortization and depreciation are taken into account in operating profit. operating cash flows represent the operating lifeblood of the business after paying the necessary expenses for financing and taxes. The investment section simply tracks additions and reductions to fixed assets and investments during the year and corresponds primarily to the long-term assets side of the balance sheet, so the most common investment inflows and outflows might be capital expenditures, which are an outflow of cash and capital expenditures are always listed as a negative number because this causes a depreciation and depletion of cash and companies must invest in some type of property, plant and equipment to maintain their productive capacity, but a drought and a downward trend could indicate a company in decline, so identifying the necessary level of expenses and other cash flow investment items could be the purchase. of intangible assets or acquisitions that would be a cash outflow asset sales that could be a cash inflow and the purchase and sale of debt stocks and equity securities that could be a cash inflow or a loan in Warren looks for companies that have low capital expenditures as we mentioned above and some companies must make large capital expenditures each year to stay in business, but remember that companies with a durable competitive advantage tend to have lower capital expenditures, which is why Warren reviews net income Regarding capital expenditures using a simple ratio of net income divided by capital expenditures, look at ratios for a ten-year period and not just one year.

A company that uses 25 percent or less of capita capital expenditures based on that revenue is a company that is likely to have a lasting competitive advantage, as we see. The Treasury shares mentioned above are shares that were once issued but later repurchased by the company. Companies with a durable competitive advantage often buy back their shares rather than issuing dividends because shareholders pay taxes on the dividends, so this usually leads to an increase in profits. per share, meaning that a share buyback reduces the total shares outstanding or changes the capital structure of the company, which is more debt and less equity, and then when a company buys back its shares with other objectives in the open market and buys them at the current stock. price or through a negotiation with specific shareholders and as we see here the basic shares in circulation are equal to the total number of shares that are issued less the shares that are repurchased, which are the shares in treasury, the basic profit per share is the net income divided by the basic weighted average of shares. outstanding is a very common way investors analyze company earnings is by dividing net income by shares outstanding and this net metric is called earnings per share or EPS, earnings per share effectively measures how much of the Total earnings for the current period belong to each shareholder and Warren likes EPS growth to basically tell if a company is buying back its shares.

Go to the cash flow statement and look under Cash from investments and see if there's an item there called stock retirement, the financing cash flow section. The cash flow statement tracks changes in the company's sources of debt and equity financing, which primarily corresponds to the liabilities and shareholders' equity side of the balance sheet, and the most common inflows or outflows of financing are a common dividend payment and preferred stocks that would be a cash outflow ordinary shares issued or repurchased, which would be a cash inflow or outflow respectively and if the company issues bonds they are shared, the cash flow in a debt issue would be a cash inflow for the payment of debt it would be a cash outflowand if the company buys back shares or bonds it would be a cash outflow I look for businesses where I think I can predict what they will be like in 10 to 15 years Warren Buffett Companies with a durable competitive advantage have such predictable earnings that their shares act almost like an equity bond with an increasing coupon payment a bond equals the company's shares a coupon payment would equal the company's pretax earnings, so regardless of whether Warren is buying an entire company just for a few of his stock, he looks at the pre-tax earnings, the EBT, to see if it's a good business relative to the economics of his business and then the earnings per share increase over time, either through an increase in business operations and expansion of operations, acquisitions or share repurchases in the late 1980s.

Warren bought shares for six dollars and 50 cents, whose pre-tax earnings were 70 cents, agent rate of 10%, so what a disclaimer if you are a Graham Value investor Warren does not say that a coke is worth $60 and is trading at $40 and its value is undervalued dust: Warren this one in particular. Investment is a dream because over the years your initial investment will increase. In 1987 Warren began buying Coca-Cola shares for the average price of six dollars and 50 cents against pre-tax earnings of 70 cents and after-tax earnings of 46 cents per share, so Warren decided that a capital bonus was paid and initial pre-tax interest rates of 10.7% were paid, which is actually seven cents divided by six dollars and fifty cents on your investment of six dollars and 50 cents, so if you projected earnings of 10% per year at the end of 1996, pre-tax earnings per share were one dollar sixty-five and this equates to a pre-tax return of twenty-five percent in ten years, but after 20 years earnings per 4.28 pre-tax stock which was a 66% pre-tax return if you divide four dollars and 28 cents by six dollars and 50 cents, so the stock market sees this return over time and revalues the share price to reflect it, so to calculate the share price we divide the pre-tax price. -tax earnings per share by the corporate interest rate, so in 2007 earnings per share before taxes were three dollars and 96 cents per share for Coca-Cola and the corporate interest rate was six point five per share percent, so the share price was $60. and during 2007 the market valued Coca-Cola between forty-five and sixty-four dollars per share and, because earnings are constant, the soft market follows an increase in the underlying value of the company and, as a consequence, the Companies are vulnerable to a leveraged buyout. since a leveraged buyout is when a company has a little bit of debt, has a solid earnings history, and if its stock price drops enough, another company can come in and buy it by financing the purchase with the acquired company's profits as collateral. , so if interest rates go down.

The company's earnings are worth much more because they can support that debt and the opposite is true when interest rates rise and if that's confusing to you, here's an easier way to understand a leveraged buyout. I won't go on too much, but if you bought a house with the mortgage, you essentially made a leveraged buyout, so suppose you buy a million dollar house with a six hundred thousand dollar mortgage and four hundred thousand dollars in equity, you have effectively bought a house with forty percent equity and sixty percent debt and if you sell the house for $1.5 million five years later and assuming that you have paid two hundred thousand dollars of your mortgage in those five years and that the price of house has increased by 50%, so your cash-on-cash return is 2.75 times your equity increased from $400,000 to 1.1 million We're in the home stretch here, but we can't really talk about Warren Buffett's investing style without discussing the intrinsic value, which was a 66% pre-tax return on a six dollar and fifty cent equity bond in 2007, with a value in 1987. the time value of money, a dollar today is worth more than a adult dollar tomorrow, but to solve this problem you had to calculate the intrinsic value of coke the intrinsic value of a stock is its real value first calculate the discounted cash flows over 20 years add the discounted cash flows to calculate the present value for 20 years, then calculate the intrinsic value per share and then compare the intrinsic value per share with the current share price in the book, the author barely explains the intrinsic value, that is a disclaimer so I will do it Review the intrinsic value calculation in future videos when we review some of the books the mother owns, but for now let's just review how the authors did it, so remember that Lauren asks what was the 66% pre-tax return on six dollars.and a fifty-cent stock bond in 2007 with a value in 1987, so they multiplied the stock price by a discount rate of 70 17 percent to arrive at a stock price of one dollar and dime in 1987 and that seventeen percent discount rate is really a judgment call then.

They multiplied that relationship of one dollar times ten cents and two points between the price of colas and the profits of fourteen in 1987 to arrive at an intrinsic value of fifteen dollars and forty cents. Warren argues that if you buy a stock for six dollars and 50 cents in 1987 and hold it for twenty years, its intrinsic value in 1987 is fifteen dollars and forty cents and, in case you were wondering, in 2007 you conclude that Cola was trading at $64 per share, needless to say, what you pay for your shares and the price at which you sell them are directly invested. affects your investment, the best time to buy a big company is during a bear market, when bargains are most likely to be found, and generally the worst times are during bull markets, when price-earnings multiples are quite inflated and Warren maintains actions for so long. as possible and, furthermore, when you sell or receive dividends, those profits are also subject to taxes, which tends to decrease your chances of getting rich, so it is a good idea to sell if you need the capital to buy an even better company. with which you can get at a great price, another time to sell is if the company is about to lose its durable competitive advantage and finally, bull markets are a good time to sell because price-earnings multiples are inflated and You can hold onto the cash or buy government bonds until the next bear market, so let's summarize Warren's pearls of wisdom from this book.

Analyzing financial statements is like detective work. It takes a critical eye to notice financial shenanigans. Companies that have a durable competitive advantage have consistently higher gross margins. These companies own a part. in the minds of consumers and therefore do not have to change their product or service offerings. Companies that do not have a durable competitive advantage have wide variations in their signature; However, less than 30% is what we look for for companies that have to spend large amounts. of money in indirect operating costs have an inherent defect in their competitive advantage and long-term economic depreciation should always be used in the calculation of profits if it is a short-term illusion does not include infrequent or unusual events of net profits for at less picture of what is happening in the company ten-year earnings per share should be trending upward and should be consistent a company with excess cash can probably withstand short-term problems if it is generating cash through its business operations in course look for companies where inventory and cash increase together, property, plant and equipment are capital expenditures that decrease cash, review total assets to assess how difficult it would be for a competitor to enter the business, companies with a competitive advantage durable require little or no long-term debt.

Look for a current ratio greater than 1, but because of their high purchasing power they can pay dividends and buy back their shares, which could reduce their cash reserves and lower the current ratio so that companies with a durable competitive advantage have enough profits. to pay off all long-term debt and over three to four years an adjusted platform-to-equity ratio of 0.8 or less will likely have a lasting competitive advantage. Companies with a durable competitive advantage do not tend to have preferred stock, but they do tend to have treasury stock, large companies use their retained earnings to acquire other businesses to further increase their retained earnings, companies with a durable competitive advantage have excellent return on equity ratios, which is reflected through an increase in the company's share price, a company that uses 25% or less for capital expenditures based on those revenues, then the company It probably has a dirty competitive advantage, regardless of whether Warren is buying an entire business or just some of its shares.

Look at earnings before taxes, EBT, to see if it is a good deal relative to your business economics to buy shares during bear market trades and sell the company when it is about to lose its comparable competitive advantage to sell shares during bear markets. bullish when price-earnings multiples are inflated far beyond their intrinsic value and price to earn multiples above 40 might be the time to sell a stock, this video ended up being a lot longer than I expected, but I definitely think it was worth it. I highly recommend you not to read this book but study it if you are interested in Warren Buffett's investment style or If you also want a simple introduction to accounting, if you liked this video, please hit the like button, leave a comment , share this video and subscribe to my channel.

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