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WARREN BUFFETT AND THE INTERPRETATION OF FINANCIAL STATEMENTS

May 10, 2020
Warren Buffett is one of the richest men in the world. One of the key components of his multi-billion dollar success has been his ability to buy companies with a sustainable competitive advantage. Think Coca-Cola, Moody's or See's Candy. For this video, we'll see if we can emulate his success on how to make money by learning to identify companies with such a sustainable competitive advantage; More specifically, we will learn how to do this by analyzing a stock market. The

financial

statements

of the company: the income statement, the balance sheet and the cash flow statement. This is a video of Warren Buffett's top 5 takeaways and

interpretation

of

financial

statements

written by Mary Buffett and David Clark.
warren buffett and the interpretation of financial statements
Warren Buffett cannot emphasize enough how important it is for an investor to be able to understand these statements. He says they are the language of business and even goes so far as to say that if you don't understand them, you have no business investing in individual stocks. But don't worry, digesting financial statements can be a lot of fun. At least Warren Buffett himself thinks the same when he says: "Others read Playboy, I read the annual reports." This man has clear priorities. Conclusion #1: Consistency is King Warren Buffett is known for saying that the best holding period for an investment is forever.
warren buffett and the interpretation of financial statements

More Interesting Facts About,

warren buffett and the interpretation of financial statements...

Here's a quick test: Which product do you think is most likely to remain popular in 2050? A: Coca-Cola, which has been popular for at least 120 years and has remained basically the same product throughout. B: Snapchat, which has been popular for about 7 years. The answer is quite obvious. When Warren Buffett looks for investments with a sustainable competitive advantage, he wants to see consistency. Consistency in earnings. Low and constant debt. Constantly growing profits. Consistently low spending on capital expenditures and R&D. Constant profitability, etc. Looking at the last 10-year period is a good start, but as in the case of Coca-Cola, the longer the company has been demonstrating its durability, the better.
warren buffett and the interpretation of financial statements
Selling the same product for many years, such as Coca-Cola, has a big advantage for you as a stock owner: it greatly reduces costs. - Reduces production costs as the need to upgrade machinery decreases - Reduces marketing costs as marketing efforts are cumulative - Reduces research and development costs (right?) - Reduces training costs employees - Reduces the risk of having obsolete inventory And when costs are reduced a lot, it means a lot more money in the pockets of shareholders. Not only are costs reduced in these companies, but you can also enjoy tax-free compound interest when your holding period is indefinite, something that has made Warren Buffett tremendously rich over the past 50 years.
warren buffett and the interpretation of financial statements
Conclusion number 2: What Warren Buffett looks for in an income statement To illustrate what Buffett looks for, we will use one of his largest and most recent investments: Apple. First, I will assume that he knows some basic concepts about financial statements. If not, head to my summary of The Interpretation of Financial Statements by Benjamin Graham for some investing basics. Let's start by taking a look at the final result to confirm what we talked about in the previous conclusion. The company's net profits have shown great consistency over the past 10 years. It's true that it doesn't have Coca-Cola's track record and, in my opinion, its products aren't as durable either, but the iPhone has looked pretty similar since its launch in 2007.
Plus, Apple's profits have been growing at a pace constant too. Another thing Warren Buffett wants to see in his investments is a high and consistent gross margin. As a general rule, you'll want to see a margin greater than 40%. We can see that Apple just makes the cut here. It's always interesting to compare with the competition, so as a benchmark, Samsung had a gross margin of 45.7% in 2018 and Huawei had a margin of 38.6%. Having a high gross margin usually says something about the scalability of the business, meaning that the more the company sells, the greater the profitability. This is a trait you would like to see in any business you own.
Finally, we want to compare the bottom line with the top line and calculate the net margin. Companies with a durable competitive advantage have higher net margins than their competitors. Apple surpasses both Samsung and Huawei in this regard. And here's another rule of thumb: a net margin of 20% or more is usually a very solid result that shows that we are looking at a smoothly run business. Conclusion number 3: What Warren Buffett looks for in a balance sheet. Next is the balance. Warren Buffett likes to look at a number called retained earnings. The figure is added or removed each year depending on whether or not the company reinvests its net income.
Buffett typically likes to see steady growth here, which means the business is profitable and he identifies good reinvestment opportunities. If you look at Berkshire Hathaway's retained earnings, for example, we see very strong growth over the last decade. Apple doesn't really meet the criteria for retained earnings, but you also have to keep in mind that starting in 2013, Apple began a fairly extensive dividend and share buyback program. We will get to this in the next conclusion. To measure how efficiently a company uses these reinvested profits, return on equity can usually be used. To calculate this, we must review the income statement and compare net income with the company's total equity.
Apple is showing a lot of strength in this regard, which is partly an effect of distributing much of the profits to shareholders, but is also a sign that a company has a lasting competitive advantage. In comparison, Samsung and Huawei are not even half as profitable. In his 1983 letter to shareholders, Warren Buffett suggests a somewhat more sophisticated approach to measuring how efficiently a company uses its capital. He suggests calculating the so-called return on net tangible assets. More on this in Warren Buffett's Essays. A third thing to keep in mind is that exceptional businesses rarely require a lot of debt to expand (perhaps banks are an exception).
Usually you can only use the strong cash flow of the business. Therefore, look for companies with little or no long-term debt. If a company can pay off all of its long-term debt with less than four years of earnings, it's in a pretty good position. Apple clearly meets this criterion and so do its competitors. Takeaway #4: What Warren Buffett Looks For in a Cash Flow Statement Finally, the third financial statement you should delve into is the cash flow statement. A cash flow statement differs from an income statement in that it represents the real ins and outs of money, while the income statement is a measure of financial performance.
Yeah, I'll probably make my own video on this in the future. He comments “I want it!” below if you want... well, if you want a video like that. For now, just know that an important figure is capital expenses. This is money spent primarily on property, plant and equipment. Look at what percentage capital expenses are of net profits and you want them to be as low as possible. Less than 25% is considered very good and less than 50% is acceptable. However, there are exceptions: such as when a company makes a one-time payment to grow the business. Look at what the company is using the money for.
Apple is doing very well here, almost every year they have capital expenditures below 25%. The same cannot be said for its competitors. Additionally, in the cash flow statement we can see why the retained earnings on the balance sheet haven't grown much since 2012. Apple has been distributing a LOT of cash to its shareholders. The so-called boosted payout ratio, which includes share buybacks and dividends, has been above 100% for a few years, which basically means that Apple distributes more money than it earns. Takeaway #5: When to Sell As I've mentioned before, one of Warren Buffett's key concepts on how to invest in stocks successfully is to hold on to your investments forever.
Still, there are three cases in which he might consider selling a stock. 1. You need more for an even better investment Sometimes, perhaps especially in bear markets, there are so many opportunities for everyone that you should consider switching from something that is great to something that is exceptional. In 1974, Warren Buffett said this, noting that many stocks were undervalued: “I felt like an oversexed guy in a harem.” 2. When a company can lose its competitive advantage Times are changing. For example, the once monopolistic features of local newspapers are now being disrupted by online media. If one of your investments faces such a risk, it may be time to reduce it. 3.
During crazy bull markets Even a fantastic business can be a bad investment if you have to buy it at a crazy price. And equally, there are times when you can improve your personal finances by selling a fantastic business at that price, if you already have one. Buffett and David Clark suggest that with a PE ratio of 40 or higher you should start considering selling your shares, even if you believe in the underlying economics of the company. That's all! A quick summary: When you're looking for a business with a lasting competitive advantage, the key word is consistency. On the income statement, look for steadily growing net profits and profit margins that consistently beat competitors.
When looking at the balance sheet, remember that the top. The business has a high return on equity, rarely requires much debt, and retained earnings generally show steady growth. On the cash flow statement, you want to make sure the business is making money for its shareholders by examining its equity. expenses Even a fantastic business should be sold if it needs money elsewhere, its competitive advantage is at stake, or if the price is at an insane level. There are many other takeaways in “Warren Buffett and the Interpretation of Financial Statements” that I couldn't cover in this video. Please consider supporting the channel by getting the book from the link below.
Also, I already made some videos on Warren Buffett's investment strategy. If you feel like you can't get enough of the Oracle of Omaha, click on my Warren Buffett Book Playlist. Health.

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