Warren Buffett and the Interpretation of Financial Statements (Audiobook)

introduction For 12 years, from 1981 to 1993, I was the daughter-in-law of Warren Buffett, the world's most successful investor and now its greatest philanthropist, shortly after marrying Warren's son Peter, and long before most of the world Outside of Wall Street I would have heard of him. Warren visited his family's home in Omaha while there I met a small group of devoted students of the wisdom of master investors who referred to themselves as buffetologists. One of the most successful buffetologists. David Clarke kept notebooks full of Warren's investing wisdom, which were meticulous and endless. Fascinating to read, his notebooks were the basis on which he and I later shaped the internationally best-selling investment books, Warren Buffett's Dao Buffetology, the Buffetology Workbook, and the New Buffetology, which is now They are published in 17 languages, including Hebrew, Arabic, Chinese, and Russian.

After the tremendous success of Warren Buffett's Dao, I met up with David in Omaha during the 2007 Berkshire Hathaway Annual Meeting and over lunch we got into a discussion about the story. of investment analysis david noted that investment analysis during the late 19th and early part of the 20th century focused primarily on determining the solvency and purchasing power of a company for the purposes of bond analysis and that benjamin graham, the dean of wall street and

warren

's mentor, had adapted early bond analysis techniques to common stock analysis, but graham never made the distinction between a company that had a long-term competitive advantage over its competitors and one that did not, He was only interested in knowing if the company had enough purchasing power to get out of the economic problem that had sent its share price into a downward spiral. he wasn't interested in having a position in a company for 10 or 20 years if he didn't move after two years he was out, it's not that Graham missed the boat, he just didn't get on board whoever had. he made him, like Warren, the richest man in the world.

Warren, on the other hand, after beginning his career at Graham, discovered the tremendous wealth-creation economics of a company that possessed a long-term competitive advantage over its competitors. Warren realized that the longer you held one of these fantastic businesses the richer you were, while Graham would have argued that all of these super businesses were overpriced. Warren realized that he didn't have to wait for the stock market to offer him a bargain price; even if he paid a fair price, he could do it. He can still get super rich from those businesses in the process of discovering the advantages of owning a business with a long-term competitive advantage.

Warren developed a unique set of analytical tools to help identify these special types of businesses, although they are rooted in grandma's old school and language, his new way of looking at things allowed him to determine whether the company could survive its actual problems. Warren's form also told him whether or not the company in question possessed a long-term competitive advantage that would make him super rich in the long run. At the end of lunch I asked David if he thought it would be possible to create a small, easy-to-use guide. to read a company's

financial

statements

using the unique set of tools Warren had developed to uncover these wonderfully profitable businesses.

I imagined a simple and easy way. to understand a book that would teach investors how to read a company's

financial

statements

to look for the same types of companies that

warren

makes a book that would not only explain what a balance sheet and income statement are, but would point out what investors should look for. Investors like Warren are looking for a company that has a long-term competitive advantage. David loved the idea and within a month we were exchanging chapters of the book. Now you are listening to Warren Buffett and the

interpretation

of financial statements. We hope that this book will help you take the quantum leap that Warren took by allowing you to go beyond valuation and old-school models and discover, as Warren did, the phenomenal long-term wealth-creating power of a company that has a lasting competitive advantage over its competitors in In the process, you will free yourself from the costly manipulations of Wall Street and have the opportunity to join the growing ranks of savvy investors around the world who are becoming filthy rich by following in the footsteps from this legendary and masterful investor mary

buffett

july 2008.

To understand accounting and you have to understand the nuances of accounting, it is the language of business and it is an imperfect language, but unless you are willing to put in the effort to learn accounting, how to read and interpret financial statements, you really shouldn't pick stocks yourself. warren

buffett

chapter one two big revelations that made warren the richest person in the world in the mid-60s warren began to reexamine benjamin graham's investment strategies in doing so, he had two surprising revelations about what types of companies would make the best investments and the majority of long-term money as a direct result of these revelations, he altered the gram-based value investing strategy he had used up to that point and in the process created the largest wealth investing strategy the world has ever seen. ever seen.

That's the purpose of this. book to explore Warren's two revelations one: how you identify an exceptional company with a durable competitive advantage two how you value a company with a durable competitive advantage to explain how your unique strategy works and how you use financial statements to put your strategy in practice a practice that has made him the richest man in the world chapter 2 the type of business that will make warren super rich to understand warren's first big revelation we need to understand the nature of wall street and its main actors although wall street provides many services to For the past 200 years, it has also served as a large casino where gamblers, disguised as speculators, place massive bets on the direction of stock prices.

In the early days, some of these players rose to great wealth and prominence, becoming the colorful characters that people loved. read in the financial press about the great diamond jim brady and bernard baruch are just a few who were brought before the public as master investors of their time in modern times institutional investors mutual funds hedge funds and investment trusts have replaced the great speculators of yesteryear Institutional investors sell themselves to the masses as highly skilled stock pickers who flaunt their annual results as advertising bait for a short-sighted, get-rich-quick audience. As a general rule, stock speculators tend to be a skittish bunch who buy on good news and then jump on bad news. news, if the stock doesn't move in a couple of months, they sell it and go look for something else.

The best of this new generation of players have developed complex computer programs that measure the speed with which the price of a stock rises. or falling if a company's stock rises fast enough the computer buys if the stock price falls fast enough the computer sells, creating many jumps in and out of thousands of different stocks, it is not uncommon for these investors on computers skip one day, and then skip to the next, hedge fund managers use this system and they can make a lot of money for their clients, but there is a problem: they can also lose a lot of money for their clients, and when they lose money, those Clients, if they have any money left, get up and leave to go find a new stock picker to pick stocks for them.

Wall Street is littered with stories about the rise and fall of popular and not-so-popular stock pickers. This speculative buying and selling frenzy has been going on for a long time. One of the great buying frenzies of all time in the 1920s sent stock prices into the stratosphere, but in 1929 came the crisis that caused As stock prices fell in the early 1930s, an enterprising young Wall Street analyst by the name of Benjamin Graham noticed that the vast majority of top stock pickers on Wall Street didn't care at all about the long-term economy. term of the companies they were busy buying and selling, the only thing they cared about was whether the stock prices went up.

The short term went up or down. Graham also noted that these stock pickers, while caught up in their speculative frenzy, sometimes drove up stock prices to ridiculous levels relative to the long-term economic realities of the underlying businesses. He also realized that these same hot shots sometimes caused stock prices to spiral down to insane lows that similarly ignored companies' long-term prospects. It was at these insane lows that Graham saw a fantastic opportunity to make money. Graham reasoned that if he bought these oversold businesses at prices below their long-term intrinsic value, eventually the market would recognize his mistake and revalue them upwards.

Once they were revalued upwards, he could sell them at a profit. This is the basis of what we know today as value investing graham was the father of this However, what we need to realize is that Graham didn't really care what type of business he was buying in his world, each business had a price for which it was a bargain when he started practicing value investing in the 1930s he focused on. Finding companies trading at less than half of what they had in cash, he called it buying a dollar for 50 cents. He also had other standards, such as never paying more than 10 times a company's earnings and selling the stock if it went up 50 percent if it didn't go up in two years he would sell it anyway yes, his outlook was a little longer than the from Wall Street speculators, but he really had no interest in where the company would be in 10 years.

Warren learned value investing from Graham. at Columbia University in the 1950s and just before Graham retired, she began working for him as an analyst at Graham's Wall Street firm, while there Warren worked alongside famed value investor Walter Schloss, who He helped teach young Warren the art of spotting undervalued situations by having read the financial statements of thousands of companies after Graham retired. Warren returned to his native Omaha, where he had time to reflect on Graham's methodology away from the Wall Street crowd. During this period, he noticed some things about his mentor's teachings that he found troubling.

The first thing was that not all of Graham's undervalued companies were revalued upwards, some actually filed for bankruptcy and with each set of winners came quite a few losers as well, which greatly affected overall performance. Graham tried to protect himself against this scenario by managing a broadly diversified portfolio. sometimes they contained a hundred or more companies. Graham also adopted a strategy of dumping any stocks that did not rise after two years, but at the end of the day many of his undervalued stocks remained undervalued. Warren discovered that a handful of the companies that Graham had bought and then sold under Graham's 50 percent rule continued to prosper year after year in the process he saw the stock prices of these companies soar far above where They were when Graham unloaded them, it was like buying seats on a train ride at easy street, but he got off long before the train reached the station because he had no idea where it was going.

Warren decided he could improve his mentor's performance by learning more about the business economics of these superstars, so he began studying the financial statements of these companies from the perspective of what made them such fantastic long-term investments, which What Warren learned was that all of these superstars benefited from some type of competitive advantage that created a monopoly-like economy that allowed them to charge more or sell more of their business. products in the process made much more money than their competitors Warren also realized that if a company's competitive advantage could be maintained over a long period of time if it was durable, then the underlying value of the business would continue to increase year after year given Ante a continued increase in the underlying value of the business, it made more sense for Warren to hold the investment as long as he could, giving him a greater opportunity to benefit from the company's competitive advantage.

Warren also noted that Wall Street through value investors or speculators or a combination of both would recognize at some point in the future the increase in valueunderlying the company and would drive its share price up. It was as if the company's enduring competitive advantage made these business investments a self-fulfilling prophecy. There was something else that Warren found even more financial magic because these companies had such incredible business economics working in their favor that there was no chance of them ever going bankrupt, this meant that the more lower Wall Street speculators drove the stock price, the less risk Warren had of losing his money when he bought stocks at lower prices also meant greater profit potential and the longer he held these positions, the more time he would have to profit from these trades.

Great underlying economy. This fact would make him filthy rich once the stock market finally recognized that these companies were continuing to have good luck, all of this was a complete reversal of the Wall Street dictum that to maximize your profits you had to increase your underlying risk Warren had found the holy grail of investments, he had found an investment where, as his risk decreased his profit potential increased to make things even easier. Warren realized that he no longer had to wait for Wall Street to offer him a bargain price; He could pay a fair price for one of these super businesses and still come out ahead as long as he maintained the investment for a long time. enough and adding icing to an already delicious cake, he realized that if he held the investment for the long term and never sold it, he could effectively defer capital gains taxes far into the future, allowing his investment to compound free of taxes year after year, as long as you maintain it, let's look at an example in 1973, Warren invested $11 million in the Washington Post Company, a newspaper with a lasting competitive advantage, and has remained married to this investment to this day for In the 35 years that he has maintained this investment, its value has grown to an astronomical 1.4 billion dollars.

Invest 11 million dollars and earn 1.4 billion dollars. It is not bad at all and the best part is that because Warren has never sold a single share. , still has to pay a penny of taxes on any of his profits, Graham, on the other hand, under his 50 percent rule would have sold Warren's Washington Post investment in 1976 for about $16 million and paid a capital . Earns a 39 percent income tax on your profits, worse yet, Wall Street's best stock pickers have probably owned these stocks a thousand times over the last 35 years with 10 or twenty percent gains here and there and have paid taxes every time they sold them.

But Warren took advantage of it to earn a fantastic return of twelve thousand four hundred and sixty percent and to this day has not paid a cent in taxes on his $1.4 billion earnings. Warren has learned that time will make him super rich when he invests in a company. that has a lasting competitive advantage working in its favor chapter 3 where Warren begins his search for the exceptional company before he begins to search for the company that will make us rich, which is a company with a lasting competitive advantage, it helps if we know where to look Warren has discovered that these super companies come in three basic business models: they sell a unique product or service or they are low-cost buyers and sellers of a product or service that the public constantly needs, let's take a look at each of them sells a unique product this is the world of coca-cola pepsi wrigley hershey budweiser coors brews the washington post procter gamble and philip morris through the process of need and customer experience and advertising promotion the producers of these products have placed the stories of their products in our minds and in doing so they have induced us to think about their products when we are going to satisfy a need we want to chew a piece of gum you think of Wrigley you feel like having a cold beer after a hot day at work you think of Budweiser and things are better with Coca-Cola.

Warren likes to think that these companies own a piece of the consumer's mind, and when a company owns a piece of the consumer's mind he never has to change his products, which, as he will discover, is a good thing. The company can also charge higher prices and sell more products, creating all kinds of wonderful economic events that appear on the company's financial statements by selling a unique service This is the world of Moody's H R Block Corporation Incorporated American Express Company The Service Master company and Wells Fargo and companies like lawyers or doctors, these companies sell services that people need and are willing to pay for, but unlike lawyers and doctors, these companies are institutional-specific rather than person-specific.

When you think about doing your taxes, you think about the human resources block. You don't think about Jack, the guy from HR Block who pays your taxes, when Warren bought Solomon Brothers, an investment bank that is now part of Citigroup and which he later sold, he thought he was buying an institution, but when top talent They began to leave the company. The company's most important customers realized that they were specific people in companies with specific people who workers can demand and get a large share of the company's profits, leaving a much smaller fund for the shareholders who own them. company and getting the smallest fund is not how investors get rich.

The economics of selling a unique service can be phenomenal. A company does not have to spend a lot of money redesigning its products nor does it have to spend a fortune building a production plant and storing its products. Companies that sell unique services own a portion of your business. The consumer mind can produce better margins than companies that sell products by being the low-cost buyer and seller of a product or service that the public has a constant need for. This is the world of Walmart Costco Nebraska Furniture Mart Borsheim's Jewelers and Burlington Northern Santa Fe. Here large margin railroads are traded for volume and the increase in volume more than offsets the decline in margins.

The key is to be both the low-cost buyer and seller, allowing you to earn higher margins than your competitors. and remain the low-cost seller of a product or service, the story of having the best price in town becomes part of the consumer story of where to shop in Omaha, if you need a new stove for your home, go to Nebraska Furniture Market. For the best selection and the best price, you want to ship your products across the country, Burlington Northern Santa Fe Railroad can give you the best deal for your money, you live in a small town and want the best selection with the best prices, go to Walmart, that is. simply sell a single product or service or be the low cost buyer and seller of a product or service and you can get paid year after year like you broke the bank in monte carlo chapter 4 durability is warren's ticket to the wealth warren has I learned that it is the durability of competitive advantage that creates all wealth.

Coca-Cola has been selling the same product for the last 122 years and there is a good chance that it will sell the same product for the next 122 years. It's this consistency. in the product that creates consistency in the company's profits if the company does not have to keep changing its product, it will not have to spend millions on research and development nor will it have to spend billions on restructuring its plan to manufacture next year's model so that money builds up in the company's coffers, which means it doesn't have to have a lot of debt, which means it doesn't have to pay a lot of interest, which means it ends up with a lot of money to expand its operations or buy back its assets. shares, which will increase the company's earnings and stock price, making shareholders richer, so when Warren analyzes a company's financial statements, he looks for consistency.

Do you have consistently high gross margins? Does it consistently have little or no debt Does it not have to constantly spend large sums on research and development Does it show constant profits Show constant growth in profits Is it this consistency that is reflected in the financial statements that gives notice of the durability of competitiveness of the company's advantage the place Warren goes to discover whether or not the company has a lasting competitive advantage is its financial statements chapter 5 overview of financial statements where the gold is hidden the financial statements are where Warren mines companies With the lasting competitive advantage of gold is the company's financial statements that tell you whether you are looking at a mediocre business always tied to poor results or a company that has a lasting competitive advantage that will make you super rich.

Financial statements come in three different flavors: First is the income statement, the income statement. The statement tells us how much money the company earned during a given period of time. Company accountants traditionally generate income statements for shareholders to view for each three-month period during the fiscal year and for the entire fiscal year using the company's income statement. Warren can determine things like the company's margins, its return on equity, and, most importantly, the consistency and direction of its profits. All of these factors are necessary to determine whether the company is benefiting from a lasting competitive advantage. The second type is balance.

The balance tells us how. How much money the company has in the bank and how much money it owes, subtract the money owed from the money in the bank and we get the net worth of the company. A company can create a balance sheet for any given day of the year that shows what it owns, what it owes, and its net worth for that particular day. Traditionally, companies generate a balance sheet for shareholders to see at the end of each three-month period called quarter and at the end of the accounting or fiscal year, Warren has learned to use some of the balance sheet entries, such as the amount of cash the company has or the amount of long-term debt it has, as indicators of the presence of an advantage lasting competitiveness.

Third, there is the cash flow statement. Tracks cash coming in and out of the business Cash flow statement is good for seeing how much money the company is spending on capital improvements Also tracks sales and buybacks of bonds and stocks A company will usually issue a cash flow statement along With his Other Financial Statements, in the following chapters we will explore in detail the income statement balance sheet and cash flow statement entries and indicators that Warren uses to discover whether or not the company in question has a lasting competitive advantage that will make it rich. long-term.

Chapter 6 where warren looks for financial information in the modern internet era there are dozens of places where a company's financial statements can be easily found. The easiest access is through msn.com or the Yahoo Finance website www.finance.yahoo.com. We use both, but Microsoft Networks msn.com has more detailed financial statements to get you started, find where you type the symbol for stock quotes on both sites, then type the company name, click on it when it appears and both MSN and Yahoo It will take you to that company's stock quote page on the left, you will find a heading called financials, below which are three hyperlinks that will take you to the company's balance sheet income statement and cash flow.

Above under the sec heading is a hyperlink to documents filed with the U.S. Securities and Exchange Commission (SEC). All publicly traded companies are required to file quarterly financial statements with the SEC. These are known as eight tails. A document called a 10k, which is the company's annual report, is also filed with the SEC. Contains the financial statements of the company. Accounting or Fiscal Year Warren has read thousands of 10k's over the years as they do the best job of reporting the numbers without all the nonsense that can be included in a shareholder's annual report for the hardcore investor.

Bloomberg.com offers the same services and much more for a fee, but honestly, unless we're buying and selling bonds or currencies, we can get all the financial information we need to build a stock portfolio for free from MSN and Yahoo, and free financial information always makes us smile. The income statement you should read. a million corporate annual reports and their financial statements Warren Buffett some men read Playboy I read annual reports Warren Buffett chapter 7 where Warren begins the income statement in his search for the magic company with a lasting competitive advantage Warren always starts with revenue of the company's income statement Financial statements tell the investor the results of the company's operations over a period of time.certain period of time.

They are traditionally reported every three months and at the end of the year the income statements are always labeled for the period they cover, such as January 1, 2007 to December. 31, 2007 An income statement has three basic components: first there are the business income, then there are the company's expenses, which are subtracted from the company's income and tell us if the company made a profit or had a loss. Sounds simple, right? In the early days of stock analysis, leading analysts of the time, such as Warren's mentor Benjamin Graham, focused exclusively on whether or not the company was producing profits and paid little or no attention to the long-term viability of the company. source of company profits.

As we discussed earlier, Graham didn't care if the company was an exceptional business with a great economy working in its favor or if it was one of thousands of mediocre companies struggling to get by. Graham would buy a lousy business in a heartbeat if he thought he could get it cheap enough. Part of Warren's idea was to divide the business world into two different groups. First, there were companies that had a durable, long-term competitive advantage over their competitors. These were the companies that, if he could buy them at a reasonable price. a fair or better price would make him super rich if he kept them long enough.

The other group was made up of all the mediocre companies that struggled year after year in a competitive market that made them bad long-term investments in Warren's search for one of these amazing businesses. He realized that the individual components of a company's income statement could tell him whether or not the company possessed the super wealth that created a durable, long-term competitive advantage that he so coveted—not just whether the company was making money or not, but also what kind of margins it had. If you needed to spend a lot on research and development to keep your competitive advantage alive and if you needed to use a lot of leverage to make money, these factors comprise the type of information you extract from the income statement to understand the nature of a company's results. economic engine for Warren the source of profits is always more important than the profits themselves.

For the next 50 chapters we will focus on the individual components of a company's financial statements and what Warren is looking for to know if this is the type of business that will send him into poverty or the golden business with a lasting competitive advantage to long term that will continue to make him one of the richest people in the world. Visit www.tantor.com keyword financial to view a sample income statement chapter. 8 income where money appears on the first line of the income statement is always total or gross income. This is the amount of money that came in the door during the time period in question which is reported quarterly or annually, if we make shoes and sell shoes worth 120 million dollars in a year, we will report 120 million dollars of total income for the year in our annual income statement, now that a company has a lot of income does not mean that it is making a profit.

To determine if a company is making a profit, it is necessary to deduct the company's expenses from its total income. Total income minus expenses equals net profits, but the total income number alone tells it. It doesn't give us anything until we subtract the expenses and figure out what the net profits are. After Warren has taken a look at a company's total income, he begins a long and careful investigation of expenses because Warren knows that one of the big secrets to earning more. money is spending less money chapter nine cost of goods sold for warren the lower the better on the income statement just below the total revenue line comes the cost of goods sold also known as cost of revenues the cost of goods sold is the purchase cost of the goods that the company resells or the cost of materials and labor used in the manufacture of the products it sells.

Cost of revenue is usually used instead of cost of goods sold if the company is in the business of providing services rather than products. They are basically the same, but one covers a little more than the other. We should always investigate exactly what the company includes in its calculation of its cost of sales or cost of revenue. This gives us a good idea of ​​how management thinks. business, a simple example of how a furniture company might calculate its cost of goods would be to start with the cost of the company's furniture inventory at the beginning of the year, add the cost of adding to the furniture inventory during the year, and then subtract the cash value of furniture inventory remaining at the end of the year, so if a company begins the year with $10 million in inventory, makes purchases of $2 million to add to the inventory, and ends the period with a inventory whose cost value is $7 million, the company's cost of goods for the period would be five million dollars, although cost of goods sold as a low number does not tell us much about whether the company has a Lasting competitive advantage or not, is essential in determining gross profit. of the business, which is a key number that helps Warren determine whether or not the company has a long-term competitive advantage.

We will discuss this further in the next chapter. Chapter 10, gross profit, gross profit margin, key numbers for Warren as he seeks long-term advantages. Gold Now, if we subtract from the company's total revenue the amount reported as cost of goods sold, we obtain the company's reported gross profit. An example of total revenue of $10 million minus cost of goods sold of $7 million equals a gross profit of $3 million. Gross profit in dollars is the amount of money the company earned on total revenue after subtracting the costs of raw materials and labor used to make the products. It does not include categories such as selling and administrative costs, depreciation, and interest costs of operating the company.

The gross profit of the business alone tells us very little, but we can use this number to calculate the gross profit margin of the company, which can tell us a lot about the economic nature of the company. The equation for determining gross profit margin is gross profit divided by total revenue. Warren's perspective is to look for companies that have some kind of lasting competitive advantage. Businesses that you can benefit from in the long term. What he has discovered is that companies that have excellent long-term economics working in their favor tend to have consistent results. Higher gross profit margins than those that do not allow me to show you the gross profit margins of companies that Warren has already identified as having a durable competitive advantage include Coca-Cola, which shows a consistent gross profit margin of 60 percent or better than the bond rating.

Moody's Company 73 percent, Burlington Northern Santa Fe Railroad 61 and the very chewy Wrigley Company 51 contrast these excellent businesses with several companies that we know have a bad long-term economy, such as United Airlines, which is in and out of bankruptcy , which shows a gross profit margin. of 14 percent from troubled automaker General Motors, which arrives in a 21 week, once-troubled but now profitable American steel with a not-so-strong 17 and the Goodyear tire that works in any weather but in a bad economy it's stuck at a not-very-impressive twenty percent. In the world of technology, a Field Warren stays away because he doesn't understand it.

Microsoft shows a consistent gross profit margin of 79, while Apple Incorporated comes in at 33 percent. These percentages indicate that Microsoft produces better economic results by selling operating systems and software than Apple. When selling hardware and services, what creates a high gross profit margin is the company's lasting competitive advantage, allowing it the freedom to price the products and services it sells well above the cost of goods sold, Without a competitive advantage that companies have to compete by reducing the price of the product or service they sell, that drop, of course, reduces their profit margins and therefore their profitability as a very general rule and there are exceptions.

Companies with gross profit margins of 40 percent or more tend to be companies with some form of enduring competitiveness. Advantaged companies with gross profit margins below 40 percent tend to be companies in highly competitive industries where competition is hurting overall profit margins. There are exceptions here too. Any gross profit margin of 20 percent or less is usually a good indicator of a fiercely competitive industry where no one company can create a sustainable competitive advantage over the competition and a company in a fiercely competitive industry without some type of competitive advantage by working at His favor will never make us rich in the long run as long as the gross profit margin test is not certain.

It is one of the first indicators that the company in question has some type of lasting and constant competitive advantage. Warren strongly emphasizes the word durable, and to be sure, we need to track annual gross profit margins for the past 10 years to ensure that the company in question has some sort of durable and consistent competitive advantage. Is there consistency? Warren knows that when we look for companies with a lasting competitive advantage, consistency is the name of the game. Now there are several ways a company with a high gross profit margin can go astray and lose its long-term profits. competitive advantage one of them is high research costs, another is high administrative and sales costs and a third is high interest costs on debt any of these three costs can destroy the long-term economics of the business.

These are called operating expenses and are the thorn in the side of every business Chapter 11 Operating Expenses Where Warren Watches Closely Just below the line on the income statement for gross profit comes a group of expenses called operating expenses These are all the hard costs. of companies associated with the research and development of new administrative and product sales costs to bring the product to market, depreciation and amortization, restructuring and impairment charges and the general remainder that includes all non-recurring non-operating expenses. When these inputs are added together, they constitute the total operating expenses of the company, which are then subtracted from the gross profit to obtain the operating profit or loss of the company, since all of these inputs have an impact on the long-term economic nature of the business, it is better if we spend the next two chapters analyzing them one by one in real terms.

Warren Fashion Chapter 12 Selling General and Administrative Expenses on the income statement under the SGA Selling General and Administrative Expenses heading is where the company reports its cost for direct and indirect selling expenses and all general and administrative expenses incurred during the accounting period, these include administration. salaries advertising travel costs legal fees commissions all payroll costs and the like in a company like Coca-Cola these expenses run into the billions and have a tremendous impact on the company's bottom line as a percentage of gross profit vary greatly from one company to another. company to company even vary with companies like coca-cola having a lasting competitive advantage coca-cola consistently spends an average of 59 percent of its gross profits on sga expenses a company like moody's consistently spends an average of 25 percent and procter gamble constantly spends around 61 percent constantly is the key word: Companies that do not have a durable competitive advantage suffer from intense competition and show wide variation in SGA costs as a percentage of gross profits.

GM over the past five years has gone from spending 28 to 83 percent of its gross profits on SGA costs Ford over the past five years has been spending 89 to 780 percent of its gross profits on SGA expenses, which it means they are losing money like crazy what happens is sales start to drop which means revenue drops but sga costs stay the same if the company can't reduce sga costs fast enough they start burning increasingly the company's gross profits in the pursuit of a company with a lasting competitive advantage, the lower the company's SGA expenses, the better if they can be kept consistently low, the better in the future.

In the business world, anything less than 30 percent is considered fantastic; However, there are several companies with a durable competitive advantage that have EMS expenses in the range of 30 to 80 percent, but if we see a company that repeatedly shows EMS expenses close to orabove 100 percent we are probably dealing with a company in a highly competitive industry where no entity has a sustainable competitive advantage. There are also companies with low to medium EMS expenses that destroy big business economics in the long run with high R&D costs. Capital expenditures. and/or interest expenses on its debt load, the information is a perfect example of a company that has a low ratio between SGA expenses and gross profits, but due to high research and development costs has seen its economics deteriorate. long term reduced to the average, but if intelligence stopped doing research and development, its current batch of products would be obsolete within 10 years and it would have to go out of business.

Goodyear Tire has a 72 SGA expense to gross profit ratio, but its high capital expenditures and interest expenses on the debt it used to fund its capital expenditures is dragging the tire maker into the red every time there is a recession, but if the good thing here didn't add debt to make all those capital spending improvements, it wouldn't remain competitive for long Warren has learned to stay away. of companies cursed with consistently high SGA expenses, you also know that the economics of companies with low SGA expenses can be destroyed by expensive R&D costs, high capital expenses or a lot of debt, avoid these types of businesses regardless of the price because it knows its inherent long-term economics are so poor that even a low selling price for the stock won't save investors from a lifetime of mediocre results chapter 13 research and development why warren stays away this is a great problem in the game of identifying companies with a durable competitive advantage What appears to be a long-term competitive advantage is often an advantage granted to the company by a patent or some technological advance if the competitive advantage is created by a patent, as is the case with pharmaceutical companies at some point when the patent will expire and the company's competitive advantage will disappear.

If competitive advantage is the result of some technological advance, there is always the threat that a new technology will replace it. That's why Microsoft is so afraid of Google's technological advances. The current competitive advantage may end. To become tomorrow's obsolescence, these companies must not only spend enormous sums of money on R&D, but, as they constantly have to invent new products, they must also redesign and update their sales programs, which means they also have to have to spend a lot on administrative and sales costs. This Merck must spend 29 of its gross profits on research and development and 49 of its gross profits on selling SGA general and administrative costs which, combined, consume a total of 78 percent of its gross profits, and even more if the Merkin company fails to invent the next new multi- selling billion-dollar drugs, loses its competitive advantage when its existing patents expire, while the leader in its fast-paced field must constantly spend approximately 30 percent of its gross profits on research expenses. and development, if it doesn't, it will lose its competitive advantage in just For a few years now, Moody's, the bond rating company, has long been a Warren favorite, with good reason.

Moody's has no R&D expenses and, on average, spends only 25 percent of its gross profits on SGA expenses, Coca-Cola, which also has no R&D costs, but has to advertise as Crazy still spends on averages only 59 of its gross profits in SGA costs with Moody's and Coca-Cola Warren doesn't have to stay up at night worrying that some drug patent is going to expire or that his company won't win the race for So, the Next technological advancement here is the Warren rule. Companies that have to spend a lot on R&D have an inherent flaw in their competitive advantage that will always put their finances at risk in the long run, which means they are not a sure thing and if it's not a sure thing Warren won't.

You are interested in Chapter 14, depreciation, a cost. Warren cannot ignore that all machinery and buildings eventually wear out over time. This wear and tear is recognized in the income statement as depreciation, basically the amount that something depreciates in a given year is a cost that is allocated against the income of that year, this makes sense, the amount by which it can be said that The depreciated asset has been used in the business of the company in the year that generated the income. An example imagines that a million-dollar printing company is purchased by XYZ Printing Corporation. This printing press has a 10-year useful life because it has a 10-year useful life.

Internal income. The service will not allow the company to spend the entire $1 million cost in the year it was purchased; instead, the press must wear out over the 10 years it is in service. A useful life of 10 years and an original cost of $1 million will mean that xyz will depreciate the printing press at a rate of thousands of dollars per year. Depreciation is a real cost of doing business because at some point in the future the printing press will have to being replaced the purchase of the printing press will affect the balance sheet one million dollars will come out of cash and one million dollars will be added to plant and equipment;

Then, for the next ten years, the depreciated cost of one hundred thousand dollars a year will appear on the income statement as an expense on the balance sheet each year. year, one hundred thousand dollars will be subtracted from the plant and equipment assets account and one hundred thousand dollars will be added to the accumulated depreciation liability account. The actual cash outlay of $1 million for the printing press will appear on the cash flow statement under capital expenditures. I would like to emphasize that the million dollar expense of the printing press is not taken in the year it is purchased, but is instead allocated as a depreciation expense to the income statement in increments of 100,000 over a 10 year period.

The street financial types have discovered that once the printing press is purchased and paid for for the hundred thousand dollars a year, the depreciation expense does not require any additional cash outlays, but it does decrease the profits that are reported to the IRS each year during the year. following. 10 years, this means that from a short-term perspective, xyz has an annual cost that isn't actually costing you any additional cash outlay, so Wall Street financial types can add that hundred thousand dollar cost to the earnings, meaning the business's cash flow can now support more debt for fun money-making ventures like leveraged buyouts.

Wall Street has an acronym for this earnings recalculation. They call it ebi tda, which means earnings before income tax depreciation and amortization. Warren says that by using ebi tda our Smart Wall Street guys don't know that eventually the printing press will wear out and the company will have to come up with another million dollars to buy a new one, but now the company is saddled with a ton of debt left over from leveraged buyout and may not have the ability to finance the purchase of a new printing press for a million dollars. Warren believes that depreciation is a very real expense and should always be included in any earnings calculation.

To do otherwise would be to deceive ourselves in the short term by making us believe that companies earn more than they really do and one does not get rich with illusions. What Warren has found is that companies that have a durable competitive advantage tend to have lower depreciation costs as a percentage of gross profit than companies that suffer from problems. Intense competition as an example, Coca-Cola's depreciation expense consistently represents around six percent of its gross profits and that of Wrigley, another holder of a durable competitive advantage, also hovers around seven percent and Procter Gamble, another favorite Warren's long-standing firm represents about eight percent, in contrast to GM, which is in a highly competitive capital-intensive business, its depreciation expenses range from 22 percent to 57 percent of its gross profits, since with any expense that eats up a company's gross profits, Warren has found that less always means more when it comes to growing the bottom line. line chapter 15 interest expense what Warren does not want interest expense is the entry of interest paid during the quarter or year on the debt that the company maintains on its balance sheet as a liability while it is possible for a company to earn more in interest than that pay, as with a bank, the vast majority of manufacturing and retail companies pay much more in interest than they earn, this is called financial cost, not operating cost, and is isolated by itself because it is not linked to any production or sales process, on the other hand, interest reflects the total debt that the company has on its books, the more debt the company has, the more interest it has to pay.

Companies with high interest payments relative to operating income tend to be one of two types: a company that is in a fiercely competitive industry where large capital expenditures are required to remain competitive or a company with excellent business economics. that acquired the debt when the company was purchased in a leveraged buyout. What Warren has discovered is that companies with a durable competitive advantage often carry little or no interest expenses long-term competitive advantage The head of Proctor and Gamble has to pay just eight percent of its operating income in interest costs The Wrigley company has to pay out an average of seven percent.

In contrast to those two companies, with Goodyear, which is in the highly competitive and capital-intensive tire business, Goodyear has to pay out an average of 49 percent of its revenue. operating income paid in interest payments, even in highly competitive businesses such as the airline industry, the amount of operating income paid in interest can be used. To identify companies with a competitive advantage, the consistently profitable Southwest Airlines pays just nine percent of its operating income in interest payments as it drifts in and out of bankruptcy. Competitor United Airlines pays 61 percent of its operating income in interest payments. Southwest's other troubled competitor, American Airlines, pays a whopping 92 percent of its operating income toward interest payments, as a general rule Warren's favorite durable competitive advantage holders in the consumer products category have payments of interest payments less than 15 percent of operating income, but keep in mind that the percentage of interest payments to operating income varies greatly from industry to industry, as an example, Well Fargo, a bank in which Warren owns a stake At 14 percent, it pays out about 30 percent of its operating income in interest payments, which seems high compared to Coca-Colas, but actually makes it one of the top five in the United States.

With the lowest and most attractive ratio, Wells Fargo is also the only one with a triple-A rating from Standard and Poor. The relationship between interest payments and operating income can also be very informative as to the level of economic danger a company is in. investment banking business that, on average, makes interest payments close to seventy percent of its operating income, if you had looked closely at the fact that in 2006 Bear Stearns reported that it was paying out 70 percent of its operating income in interest payments, but that in the quarter ending November 2007, its percentage of interest payments over operating income had jumped to 230 percent, meaning it had to dip into its stockholders' equity to make up the difference in a highly leveraged operation like Bear Stearns that spelled disaster in March.

In 2008, the once-mighty Bear Stearns, whose shares had traded as high as 170 the previous year, was forced to merge with J.P. Morgan. Morgan Chase and Company for just ten dollars per share. The rule here is really simple, in any given industry, the company with the lowest ratio of interest payments to operating income is usually the company most likely to have the competitive advantage in Warren's world. Investing in the company with a lasting competitive advantage is the only way to guarantee that we will become rich in the long term. Chapter 16 gain or loss on sale of assets and others when a company sells an asset other than inventory the gain or loss on the sale is recorded in gain or loss on sale of assets the gain is the difference between the proceeds of the sale and the book value as shown in the company's books, if the company had a building that it paid one million dollars for and after depreciating it to five hundred thousand dollars it sold it for eight hundred thousand dollars, the company would record a profit of three hundred thousand Similarly, if the building were sold for four hundred thousand dollars, the company would record a loss ofone hundred thousand dollars.

The same applies to the entrance. Another, this is where unusual and infrequent non-operating income and expense events are offset and accounted for. the income statement such events would include the sale of fixed assets such as property, plant and equipment, also included in others, would be licensing agreements and the sale of patents if classified as outside the normal course of business, sometimes these non-recurring events can significantly affect and increase a company's results, since these are non-recurring events. Warren believes they should be removed from any calculation of the company's net profits to determine whether or not the company has a lasting competitive advantage.

Chapter 17, income before taxes. The number Warren uses. Pre-tax income is a company's income after all expenses have been deducted, but before income tax is subtracted, it is also the number Warren uses when calculating the return he gets when he buys an entire business or when you buy a part. interest in a company through purchasing its shares on the open market, with the exception of tax-free investments, all investment returns are traded on a pre-tax basis and, since all investments compete with each other, it is easier to think of in roughly equal terms, when Warren bought $139 million worth of tax-free bonds in the Washington Public Power Supply System (WPPSS), paying her $22.7 million dollars a year in tax-free interest, he reasoned that $22 million after taxes was equivalent to earning $45 million before taxes to buy a business that would allow him to earn $45 million before taxes would cost him between $250 million and $300 million. of dollars, so he viewed wppss bonds as a business he was buying at a relative discount of 50.

Warren has always analyzed a company's earnings on a pre-tax basis. This allows you to think about a business or investment in terms relative to other investments. It is also one of the cornerstones. From his revelation that a firm with a durable competitive advantage is actually a kind of stock bond with an expanding coupon or interest rate, we will explore his theory of stock bonds in much greater detail toward the end of the book, Chapter 18: Income taxes paid, how Warren knows Who is telling the truth, just like every other taxpayer? American corporations have to pay taxes on their income today in the United States.

That amount is approximately 35 percent of your income. When taxes are paid, they are recorded on the income statement under the heading Income taxes paid. That? The interesting thing about income taxes paid is that the item reflects the company's true pre-tax profits. Sometimes companies like to tell the world that they are making more money than they actually do. It's shocking, isn't it one of the ways to see if they are winning? To tell the truth is to look at the documents they file with the SEC and see what they are paying in income taxes, take the number they list as pre-tax operating income and deduct 35 percent if the rest doesn't equal the amount company reported. like income taxes paid, we better start asking some questions.

We have learned over the years that companies that are busy fooling the IRS are usually working hard to fool their shareholders and the beauty of a company with a long-term competitive advantage is that it makes so much money that it doesn't have to fool no one to look good chapter 19 net profits what warren is looking for after all expenses and taxes have been deducted from a company's income we get the company's net profits this is where we find out how much money did the company make after pay income taxes? There are a couple of concepts that Warren uses when he looks at this number that help him determine if the company has a lasting competitive advantage, so why don't we start there first on Warren's list? is whether or not net earnings are showing a historical upward trend.

A single year's entry for net profits is not worth warning you about. He is interested in whether or not there is consistency in the earnings picture and whether the long-term trend is upward. can be equated to the durability of competitive advantage For Warren, the journey does not have to be easy, but he is behind a historical upward trend, but note that due to share buyback programs, it is possible that the historical trend of a company's net earnings is different from its Historical Earnings Per Share Trend Stock repurchase programs will increase earnings per share by decreasing the number of shares outstanding.

If a company reduces the number of shares outstanding, the number of shares used to divide the company's net earnings will decrease, which in turn increases per share. profits even though actual net earnings have not increased In extreme examples, the company's share repurchase program may even cause an increase in earnings per share while the company is experiencing a real decline in net earnings, although the Most financial analyzes focus on a company's actual net profits. Earnings Sharing Warren looks at the company's net earnings to see what's really going on. What he has learned is that companies with a durable competitive advantage will report a higher percentage of net profits over total revenue than their competitors.

Warren has said that if given the choice between owning a company that makes $2 billion on $10 billion in total revenue or a company that makes $5 billion on $100 billion in revenue totals, I would choose the company that earns the two billion dollars, this is because the company with two billion dollars in net profits earns twenty percent of the total revenue, while the company that earns five billion dollars earns only five percent of total revenue, so while the total revenue figure alone tells us very little about the economics of the business, its relationship to net profits can tell us a lot about the economics of the business. business compared to other businesses, a fantastic business like Coca-Cola earns 21 percent of total revenue and the amazing Moody's earns 31 percent, reflecting the superior underlying business of these companies. economy, but a company like Southwest Airlines earns a meager seven percent, reflecting the highly competitive nature of the airline business in which no airline has a long-term competitive advantage over its peers, in contrast to General Motors, even in a great year when it is not.

Losing money generates only three percent of total revenue, this is indicative of the dismal economics inherent in the super-competitive automotive industry. A simple rule and there are exceptions is that if a company shows a history of net profits of 20+ over total revenue, there is a good chance that it is benefiting from some type of long-term competitive advantage. Likewise, if a company consistently shows net profits of less than 10 percent on total revenue, it is most likely a highly competitive business in which no company has a stake. a lasting competitive advantage, this of course leaves a huge gray area of ​​companies earning between 10 and 20 percent of total revenue, which is simply filled with companies ripe for mining long-term investment gold that no one has discovered yet , one of the exceptions to this rule are banks and financial companies where an abnormally high ratio between net profits and total income usually means negligence in the risk management department, while the figures seem tempting, they actually indicate an acceptance of greater risk for easier money than in the loan game. money is often a recipe for making quick money at the cost of long-term disasters and having financial disasters is not how you get rich chapter 20 earnings per share how warren separates winners from losers earnings per share is net earnings of the company per share for the time period in question, this is a big number in the investment world because, as a general rule, the more a company earns per share, the higher its share price is used to determine earnings per share. share of the company, we take the amount of net income that the company earned and divide it by the number of shares it has outstanding, for example, if a company had net income of 10 million dollars for the year and has 1 million shares outstanding, would have earnings per share for the year of 10 a share, while an annual per share figure cannot be used to identify a company with a durable competitive advantage, an earnings per share figure for a 10-year period can give us a very clear idea of ​​whether the company has a long-term competitive advantage.

Working in her favor, what Warren is looking for is an earnings per share picture over a 10-year period that shows consistency and an upward trend. Take out a piece of paper and write down these numbers. 2008 2.95 2007 2.68 cents 2006 two dollars 37 cents 2005 two dollars 17 cents 2004 two dollars six cents 2003 ninety-five cents two thousand two one dollar sixty-five cents two thousand one one dollar sixty cents two thousand one dollar forty and eight cents 19.99 one dollar 30 cents 1998 one dollar 42 cents this shows Warren: that the company has consistent profits with a long-term upward trend, an excellent sign that the company in question has some type of long-term competitive advantage over time. your favor.

Steady profits are usually a sign that the company is selling a product or combination. of products that do not need to go through the costly process of change, the upward trend in profits means that the company's economics are strong enough to allow it to make expenditures to increase market share through advertising or expansion or use financial engineering like stock buybacks companies Warren is staying away from have an erratic earnings outlook now write down these numbers 2008 2.50 2007 45 cent loss 2006 3.89 2005 six dollars five cent loss 2004 6.39 2003 five dollars three cents two thousand two three dollars thirty-five cents two thousand one one dollar seventy-seven cents two thousand six dollars sixty-eight cents one thousand nine hundred ninety-nine eight dollars fifty-three cents one thousand nine hundred ninety-eight dollars twenty-four cents this shows a downward trend marked by losses that tells Warren that this company is in a fiercely competitive industry prone to booms and busts, booms appear when demand is greater than supply, but when demand is great, The company increases production to meet demand, which increases costs and eventually leads to oversupply in the industry.

Excess leads to falling prices meaning the company loses money until the next boom comes, there are thousands of companies like this and the wild swings in stock prices caused by each company's erratic profits create the illusion of buying opportunities for traditional value investors, but what they are really buying is a long, slow boat ride. For the nowhere on the balance sheet investor, one of the things you'll find, which is interesting and people don't think about it enough in most companies and most people, is that life tends to catch you in your weakest link, the two biggest weak links in my experience.

I've seen more people fail because of liquor and leverage borrowed money leverage Warren Buffett chapter 21 balance sheet overall one of the first things Warren does when trying to determine whether or not a company has a lasting competitive advantage is to go and see how much it has. the company into assets, think cash and property and how much money it owes suppliers, banks and bondholders to do this, look at the company's balance sheet, balance sheets, unlike income statements, are just for a given date, there is no Something like a balance sheet for the year or quarter, we can create a balance sheet for any day of the year, but it will only be for that specific date.

A company's accounting department will generate a balance sheet at the end of each fiscal quarter. It is like a snapshot of the financial situation of the company on the particular date the balance sheet is generated. Now a balance sheet is divided into two parts. The first part is all the assets and there are many different types of assets. They include cash, accounts receivable, inventory, property, plant. and equipment the second part of the balance sheet is liabilities and stockholders' equity under liabilities we find two different categories of liabilities current liabilities and long-term liabilities current liabilities means the money that is owedwithin the year that includes cash and short-term investments total inventory total accounts receivable and prepaid expenses long-term liabilities are those that mature in a year or more and include money owed to suppliers who sold us the goods taxes not Paid Bank Loans and Bond Loans Warren in his search for companies with a lasting competitive advantage is looking for certain things in each category of assets and liabilities, which we will get to a little later in the book.

Now, if we take all the assets and subtract all the liabilities, we will get the net worth of the business, which is the same as shareholders' equity. As an example, if the company had assets worth one hundred thousand dollars and liabilities worth twenty-five thousand dollars, then the company would have net worth or shareholders' equity of seventy-five thousand dollars, but if the company had assets worth one hundred thousand dollars and liabilities of one hundred seventy-five thousand dollars, the company would have a negative net worth or negative shareholders' equity of seventy-five thousand dollars assets less liabilities equal to net worth or shareholders' equity.

Well, that's the end of the balance manual, so let's jump in and see how. Warren uses the balance sheet and all of its subcategories to identify a company that has a lasting competitive advantage over its competitors. To see what the balance sheet looks like up to this point, visit www.tantor.com keyword financial chapter 22 assets this is where all the advantages are. cash, plant and equipment, patents and all the things from which wealth is made are held, they are found on the company's balance sheet under the heading assets on the balance sheet, accounting guys long ago divided the corporate assets into two distinct groups, current assets and all Other assets Current assets consist of cash and cash equivalents.

Short-term investments. Inventory of net accounts receivable and a general slush fund called other assets. These are called current assets because they are cash or can or will be converted into cash in a very short time. period of time, usually within a year, as a rule, they are listed on the balance sheet in order of liquidity, meaning how quickly they can be converted into cash. Historically, current assets have also been called quick liquid or floating assets. The important thing about them is their availability to be converted into cash and spent in case the business economics of the company begin to erode and other sources of day-to-day operating capital begin to evaporate if you cannot imagine that the sources of operating capital will be evaporate overnight, just think of Bear Stearns.

Other assets are those that are non-current, meaning they will not or cannot be converted into cash in the next year. They are listed in a separate category immediately below the current assets in this category. Long-term investments, property, plant and equipment, intangible goodwill. assets accumulated amortization other assets and long-term deferred asset charges Together these two groups of assets constitute the total assets of the company individually and collectively through their quality and quantity tell Warren many things about the economic character of a business and whether or not you possess the coveted lasting competitive advantage that will make you super rich.

That's why we're going to spend the next few chapters looking at individual asset classes and how Warren uses them to identify a company with a lasting competitive advantage, so let's take a look. Look at the categories and see how we can use them individually and collectively to help us identify the exceptional business with a long-term competitive advantage working in your favor. Chapter 23 Current Asset Cycle How money is made. Current assets are also known as working assets. assets of the business because they are in the cash cycle that goes to purchase inventory, the inventory is then sold to suppliers and converted into accounts receivable, accounts receivable when collected from suppliers then become cash, cash at inventory, to accounts receivable, to cash, this cycle repeats. over and over again and it's how a company makes money.

The different elements of the current asset cycle can tell Warren a lot about the economic nature of the company and whether or not it has a lasting competitive advantage in the market. Chapter 24 Cash and Cash Equivalents Warren's Loot Pile One of the first things Warren does is look at assets to see how much cash and cash equivalents a company has. This asset is exactly what it says it is cash or cash equivalent, such as a short-term CD in the bank three-month Treasury bonds or other highly liquid assets a high number of cash or cash equivalents tells Warren one of two things is that a company has a competitive advantage that is generating tons of cash, which is a good thing or that it just sold a business or a ton of bonds, which may not be a good thing, a low amount or the Lack of a cash reserve usually means the company has poor or mediocre finances, to determine which is which, let's look a little deeper.

In the cash asset, companies traditionally maintain a cash reserve to support business operations. Think of it as a very large checkbook, but if we earn more than we spend, the cash starts to accumulate and that creates the investment problem of what to do. With all the excess cash, which is a lovely problem as cash earns a low rate of return in a bank account or CD, cash assets are best spent on trading or investments that produce a higher rate of return. tall, what do you want? to own a short term CD that is earning four percent on your invested money or an apartment building that will give you 20 on your investment you take the apartment building the same thing happens in a business the money comes in the door and if arrives faster than operating costs can spend it begins to accumulate as it accumulates the company has to decide what to do with it traditionally companies have used excess cash to expand operations by completely new companies invest in proprietary companies Partially through the stock market they buy back their shares or pay a cash dividend to shareholders, but very often they just save it for a rainy day.

One can never be too financially prepared in our challenging and ever-changing world. A company basically has three ways to build a large stock pool. Cash: You can sell new bonds or stocks to the public, creating a reserve of cash before you use it. You can also sell an existing business or other assets the company owns, which can also create a cash reserve before the company finds others. uses or has a business going that generates more cash than the business burns. It's this scenario of a large cash reserve created by a going concern that really catches Warren's attention because a company that has a cash surplus as a result of the going concern is often a company that has some sort of advantage. durable competitiveness that works in her favor when Warren is looking at a company that is suffering from a short-term business problem and causing short-sighted Wall Street to put pressure on the company's stock.

Look at the cash or marketable securities that the company has accumulated to give you an idea of ​​whether it has the financial strength to overcome the trouble it has gotten into, so this is the rule. If we see a lot of cash and marketable securities and little or no debt, the chances of the business making it through tough times are very good, but if the company is suffering from a lack of cash and is sitting on a mountain of debt, it is probably going under. We know that not even the most skilled manager can save a simple test to see exactly what is creating all the cash is to look at the balance sheets for the last seven years, this will reveal whether the cash hoard was created by a one-time event such as the sale of new bonds or stocks or the sale of an asset or an existing business or if it was created by ongoing business operations if we see a lot of debt we are probably not dealing with an exceptional business, but if we see a ton of cash accumulating and little or no debt and no sale of new shares or assets and we also notice a history of consistent profits, we are probably looking at a great business with the lasting competitive advantage that Warren is looking for for the type of company that will make us rich in the long term so we don't forget that cash is the king when hard times come, so if we have it when our competitors don't, we can rule and get to rule is all it seems to be the chapter 25 inventory that the company needs. buy and what the company needs to sell the inventory are the products the company has stored to sell to its suppliers, since a balance sheet is always for a specific day, the amount found on the balance sheet for the inventory is the value of the company's inventory for On that date, in many companies there is a risk that inventory will become obsolete, but as we have discussed previously, manufacturing companies with a durable competitive advantage have the advantage that the products they sell They never change and therefore never become obsolete.

This is an advantage Warren wants. The key thing to look for when trying to identify a manufacturing company with a lasting competitive advantage is to look for correspondingly increasing inventory and net profits. This indicates that the company is finding profitable ways to increase sales and that the increase in sales has required an increase in sales. Inventory so the company can fulfill orders on time. Manufacturing companies with inventories that increase rapidly for a few years and then decline just as rapidly are more likely than companies trapped in highly competitive industries subject to booms and busts and with no one getting rich.

Bankruptcy Chapter 26 Net Accounts Receivable Money Owed to Business When a business sells its goods to a buyer, it does so on a cash-in-advance basis or payment due 30 days after the buyer receives the goods in some businesses cash does not overdue for even longer periods, sales in this state of limbo where cash must be paid are called accounts receivable; This is the money that is owed to the company, since a certain percentage of buyers to whom goods were sold will not pay an estimated amount for bad debts that is deducted from accounts receivable, giving us accounts receivable net accounts receivable minus bad debts equals net accounts receivable, net accounts receivable as a stand-alone number tells us very little about the company's long-term competitive advantage, however, it does tell us a lot about different companies within of the same industry in very competitive industries.

Some companies will try to get an advantage by offering better payment terms instead of 30 days. They can give suppliers 120 days. This will cause an increase in sales and an increase in accounts receivable if a company consistently shows a lower percentage of net accounts receivable to gross sales. that its competitors usually have some type of competitive advantage in its favor, that others do not have prepaid chapter 27 expenses, other current assets, companies sometimes pay for goods and services that they will receive in the near future, although they still they have not taken them. possession of the goods or received the benefits of the service although the goods or services have not been received, are paid for what are assets of the business, are recorded as current assets in the prepaid expense account, insurance premiums for the following year . that are paid in advance would be one of those prepaid expenses prepaid expenses give us little information about the nature of the business or whether it is benefiting from having a lasting competitive advantage other current assets are non-cash assets that mature within the year but are not yet in the company's hands, these include such things as deferred income tax recoveries that are due within the year but are not yet cash in hand chapter 28 total current assets and current assets ratio Totals is a number that has played an important role in financial analysis.

Analysts have traditionally argued that subtracting a company's current liabilities from its current assets gives them an idea of ​​whether the company can meet its short-term debt obligations. They developed the current ratio which is derived from dividing current assets by current assets. Liabilities: The higher the ratio, the more liquid the company. A current ratio greater than one is considered good and anything less than one is bad. If it is less than one, it is believed that the company may have difficulty meeting its short-term obligations to its creditors. The curious thing about many companies with a durable competitive advantage is that very often their current ratio isbelow the magical.

From an old school perspective it means that these companies might have difficulty paying their current liabilities, what is really happening is that their purchasing power is so strong that they can easily cover their current liabilities and as a result of their tremendous purchasing power, These companies have no problem taking advantage of their current liabilities. In the short-term cheap commercial paper market, if they need additional short-term cash due to their high purchasing power, they can also pay generous dividends and carry out share buybacks, which decreases cash reserves and helps reduce their current ratios. below one, but it is the consistency of their purchasing power that comes with having a lasting competitive advantage that ensures that they can cover their current liabilities and not fall victim to the vicissitudes of economic cycles and recessions;

In short, there are many companies with a durable competitive advantage that have current ratios. less than one of those companies creates an anomaly that makes the current index almost useless in helping us identify whether or not a company has a durable competitive advantage chapter 29 property, plant and equipment for Warren not having them can be a good thing ownership of A company's manufacturing plant and equipment and its collective value are carried on the balance sheet as an asset are carried at their original cost less accumulated depreciation Depreciation is what happens as the plant and equipment wears out little by little each year. takes a charge against the plant and Equipment companies that do not have a long-term competitive advantage face constant competition, meaning they have to constantly upgrade their manufacturing facilities to try to remain competitive, often before that said equipment wears out.

This, of course, creates an ongoing expense that is often reduced. quite substantial and continues to increase the amount of plant and equipment that the company includes on its balance sheet. A company that has a durable competitive advantage does not need to constantly upgrade its plant and equipment to remain competitive. Take, for example, the Wrigley-branded rubber manufacturer that builds. a plant that makes chewing gum and does not have to upgrade the plant and equipment until they wear out, so the company that has a durable competitive advantage replaces its plant and equipment as they wear out, while the company that does not have a durable competitive advantage competitive advantage has to replace its plant and equipment to keep pace with the competition, a company with a durable competitive advantage will be able to finance any new plant and equipment internally, but a company that does not have a competitive advantage will be forced to resort to debt to finance its constant need to restructure its plans to keep up with the competition, we see this when we take a company with a long-term competitive advantage like Wrigley, which has plants and equipment worth one point four billion dollars, has a debt of one billion dollars. and earns around half a billion dollars a year.

Compare Wrigley to the company without a lasting competitive advantage like GM, which has plants and equipment valued at $56 billion, is $40 billion in debt, and has lost money for the past two years by chewing. Chewing gum is not a product that changes much and the Wrigley brand guarantees a competitive advantage over its rivals, but GM must compete head-on with every automaker on the planet and its product mix must be constantly updated and redesigned to stay ahead of the market. competence. This means that GM plants have to be regularly retooled to produce new products. Making chewing gum is a much better business and much more profitable for shareholders than making cars.

Consider that this hundred thousand dollars invested in Wrigley in 1990 would be worth approximately five hundred. forty-seven thousand dollars in two thousand eight, but one hundred thousand dollars invested in GM in 1990 would be worth approximately ninety-seven thousand dollars in two thousand eight, this is equivalent to a difference of four hundred and sixty thousand dollars in favor of Wrigley shareholders who happily have chewed his path to wealth as gm shareholders have seen their fortunes plummet as warren says producing a consistent product that doesn't have to change equals consistent profits consistent product means no need to spend tons of money upgrading the plant and teams just to stay competitive which frees up tons of money for other companies that make money to make us rich, we have to make money first and it helps if we make a lot of money.

One of the ways to make a lot of money is to not have to spend a ton. of money to keep up with Jones Chapter 30 goodwill When Exxon buys oil company XYZ and Exxon pays a price higher than the book value of companies for a price higher than their book value and we end up with a large amount of capital gains on our balance sheet. Goodwill used to be amortized against the profits of the business through an amortization process that caused an annual charge against profits in the income statement under the heading of amortization. of goodwill in the modern era, the fasb financial accounting standards board decided that goodwill would not have to be amortized unless the company to which the goodwill was tied was actually depreciating in value increasingly If we see an increase in a company's goodwill over a number of years we can assume that it is because the company is buying other businesses.

This can be a good thing if the company is purchasing businesses that also have a durable competitive advantage if the goodwill account remains the same year after year. That's because the company is paying below a company's book value or the company isn't making any acquisitions. Companies that benefit from some kind of lasting competitive advantage almost never sell below their book value, we say almost never, but occasionally it happens and when it happens it can be the buying opportunity of a lifetime chapter 31 intangible assets measure the immeasurable intangible assets are assets that we cannot physically touch these include patents copyrights trademarks franchises trademarks and the like a long time ago a company could put on its intangibles any old valuation that it thought it could get away with, which generated some very interesting assessments and many abuses in the current era.

However, companies are not allowed to have internally developed intangible assets on their balance sheets, which has put an end to showering the balance sheet with fanciful valuations of intangible assets. Intangible assets that are acquired from a third party are recorded on the balance sheet at their fair value, if an asset has a finite life such as a patent, it is amortized over its useful life with an annual charge to the income statement and On the balance sheet Something strange generally happens with companies that benefit from a lasting competitive advantage. Take the Coca-Cola company as an example.

The Coca-Cola brand is worth more than 100 billion dollars, but because it is an internally developed brand, its real value as an intangible asset is not reflected in Coca-Cola's balance sheet. The same applies to Wrigley Pepsi Company, McDonald's and even Walmart. Each of these companies benefits from having a lasting competitive advantage tied directly to their name, but the value of their greatest asset, their name is not. recognized on their balance sheets, this is one of the reasons why the power of durable competitive advantage to increase shareholder wealth has remained hidden from investors for so long, before comparing 10 years of income statements, investors They have had no way of knowing it was there or knowing of its potential to make them super rich, which is how Warren was able to take huge positions in such visible companies as Coca-Cola with the whole world watching, but the whole world had no idea about it. why was he doing it.

Coca was too expensive to manufacture. It made no sense to value investors who followed Graham and his price was not volatile enough to be interesting to Wall Street traders. What Warren could see that no one else could was Coca-Cola's enduring competitive advantage and the long-term purchasing power that came with that purchasing power. which would eventually help him become the richest man in the world chapter 32 long-term investments one of the secrets of Warren's success an asset account on the balance sheet of a company where the value of long-term investments of more of one year, such as stocks and bonds and real estate are recorded can be seen at www.tantor.com keyword financial This account includes investments in the company's affiliates and subsidiaries.

The interesting thing about the long-term investment account is that this asset class is marked at its cost or market price, whichever is lower, but it cannot be marked at a price higher than cost, even if the investments have appreciated in value, this means that a company may have a very valuable asset that it is carrying on its books. at a valuation considerably below its market price, a company's long-term investments can tell us a lot about the investment mindset of senior management: do they invest in other companies that have durable competitive advantages or do they invest in companies that sometimes Are they in highly competitive markets?

We see the management of a wonderful company making large investments in mediocre companies for no other reason than to think that bigger is better. Sometimes we see some enlightened manager of a mediocre company making investments in companies that have a lasting competitive advantage. Here's how Warren built his Berkshire Hathaway holding company into the empire it is today Berkshire was once a mediocre company in the highly competitive textile industry Warren bought a majority stake stopped paying the dividend so cash would accumulate and then took the capital of company job and went and bought an insurance company, then took the assets of the insurance company and went on a buying spree for 40 years for companies with a lasting competitive advantage, kiss even a frog for a business enough times with a lasting competitive advantage and will become a prince of a business or, as in Warren's case, $60 billion, which is what his shares in Berkshire are now worth.

Chapter 33 Other Long-Term Assets Think of other long-term assets as a giant collection of long-term assets that have useful lives of greater than one year that do not fall into the categories of property and equipment, goodwill, intangibles, and long-term investments. term, an example of other long-term assets would be prepaid expenses and tax recoveries that will be received in future years. There is little that other long-term assets can tell us about whether or not the company in question has a lasting competitive advantage, so let's move on to Chapter 34, total assets and return on total assets, add current assets to long-term assets. term and we obtain the profitability of the company.

Total Assets Your total assets will equal your total liabilities plus stockholders' equity. They balance each other, which is why it is called balance. Total assets are important in determining how efficient the company is by using its assets to measure the efficiency of the company. Analysts have arrived at the return on assets ratio that is obtained by dividing net profits by total capital assets; However, it always presents a barrier to entry into any industry and one of the things that helps a company's competitive advantage last is the cost of assets. you have to get in the game coca-cola has $43 billion in assets and a return on assets of 12 percent procter gamble has $143 billion in assets and a return on assets of seven percent and altria group incorporated has $52 billion in assets and a return on assets of 24, but a company like Moody's, which has $1.7 billion in assets, shows a return on assets of 43, while many analysts argue that the higher the Return on Assets, Better Warren has found that really high returns on assets can indicate vulnerability.

In the durability of the company's competitive advantage, raising $43 billion to take on Coca-Cola is an impossible task, it's not going to happen, but raising $1.7 billion to take on Moody's is within the scope. than possible, while Moody's underlying economics are far superior to The durability of Moody's competitive advantage is much weaker due to the lower cost of entry into its business. The lesson here is that sometimes more can mean less in the long run. Chapter 35 Current Liabilities Current liabilities are the debts and obligations that the company's debts that are due within the fiscal year are found on the balance sheet under the headings accounts payable accrued expenses short-term debt long-term debtoverdue and other current liabilities, let's take a look at them and see what they can do to tell us whether or not a company has a lasting competitive advantage over its competitors chapter 36 accounts payable accrued expenses and other current liabilities accounts payable are money owed to suppliers who have provided goods and services to the company on credit we order a thousand pounds of coffee and they send it to us along with an invoice the invoice for the thousand pounds of coffee is an account payable the accrued expenses are liabilities that the company has incurred but not yet have been billed these expenses include sales tax payable wages payable and accrued rent payable we hire someone and tell them we will pay them at the end of the month each day they work until the end of the month is counted as an accrued expense other debts is A slush fund for all short-term debts that did not qualify for inclusion in any of these categories Accounts payable, accrued expenses and other debts can tell us a lot about a company's current situation, but as independent inputs they tell us little about the long-term economic nature of the company and whether or not it has a lasting competitive advantage;

However, the amount of short- and long-term debt a company has can say a lot about a company's long-term economics and whether or not it has a lasting competitive advantage. chapter 37 short term debt how can you take down a financial institution short term debt is money owed by the corporation that is due within the year this includes commercial paper and short term bank loans short term money has historically been more cheaper than the long term Term money, this means that it is possible to make money by borrowing short term and lending it long term. We borrow money short-term at five percent and lend it long-term at seven percent.

It sounds easy enough, but the problem with this strategy is that the money we borrow is short-term money, which means we have to pay it back within the year, which is easy enough to do, we just borrow more short-term money. to pay short-term debt that comes due in the financial world. It's called refinancing debt and everything works fine until short-term rates jump above what we loan the money long-term, which I was sure was seven percent. It seemed like a great idea when short-term rates were five percent, but now that they've jumped to eight percent we have to refinance our short-term debt at a rate higher than we lent it and that doesn't make us happy.

Another part of the short-term debt disaster equation is what happens if we lend all this money long-term. -term but our creditors decide not to lend us any more money term suddenly we have to pay back all the money we borrowed short term and we lent long term but we don't have it because we lent it long term which means we won't get it back during Many years ago, this is what happened to the bears, they borrowed short term and bought mortgage backed securities using the mortgage backed securities as collateral for the short term loans, but one day their creditors woke up and said We don't believe that The collateral is worth what you told us it was worth, so we don't want to lend you more money and we want to collect the money we lent you.

Not a good position for Bear Stearns. The smartest and safest way to make money in banking is to borrow long term and lend it long term, which is why banks are always trying to lock us into those five and ten year certificates of deposit; It is not the quick and easy money to borrow short term and lend long term, but it is a more sensible and much more conservative way of making money, which is what we want in a bank and in the sanity of a banker when Try to invest in financial institutions. Warren has always avoided companies that are bigger short-term borrowers. term money than long-term money Wells Fargo, Warren's favorite, has 57 cents of short-term debt for every dollar of long-term debt, but an aggressive bank like Bank of America has two dollars and nine cents of short-term debt per dollar. of long-term debt and while being aggressive can mean making a lot of money in the short term, it has often led to financial disasters in the long term and one never gets rich, being on the downside of a financial disaster in times of financial problems is stable conservative banks like Wells Fargo that have a competitive advantage over aggressive banks that have gotten into trouble durability equals the stability that comes with being conservative has money when others have losses which creates opportunities aggressive short borrowers term Term money is often at the mercy of sudden changes in the credit markets, which puts your entire operation at risk and amounts to a loss of any kind of durability in your business model and in the corporate world.

The durability of a competitive advantage is a lot like virginity. easier to protect than recover Chapter 38 long-term debt that is due and the problems it can cause this chapter refers to long-term debt that is due and must be paid in the current year long-term debt is not a liability annual current for most companies; However, some very large corporations have a portion of their long-term debt that matures annually, which can create problems when some companies lump it with short-term debt on the balance sheet. which creates the illusion that the company has more short-term debt than it actually does.

As a general rule, companies with a durable competitive advantage require little or no long-term debt to maintain their business operations and therefore always have little or no long-term debt. So if we're dealing with a company that has a lot of long-term debt coming due, we're probably not dealing with a company that has a long-term competitive advantage, as long as we're buying a company that has a durable competitive advantage. advantage but has been falling on hard times due to a one-time event that can be resolved, such as a subsidiary in a different business losing cash, it is best to look over the horizon and see how much of the company's long-term debt is also due in the next years.

Too much debt maturing in a single year can scare investors, giving us a lower price to buy a mediocre company that is experiencing serious problems. Too much debt maturing in a current year can lead to cash flow problems and some bankruptcy which is also a certain death for our investment and having dying investments is not the way we get rich chapter 39 total current liabilities and the current ratio by dividing the total current assets by the total current liabilities the liquidity of the company can be determined the higher the current ratio, the more liquid the company and the greater its ability to pay current liabilities when they fall due, a current ratio greater than one is considered good and anything less than one is bad, if it is below one it is thought that the company could have difficulty meeting its short-term obligations. long-term obligations to their creditors, but as we discuss in Chapter 28, companies with a durable competitive advantage often have current ratios less than one.

What causes this anomaly is the immense purchasing power that creates lasting competitive advantage. In short, we have a current economic picture that does not require the liquidity cushion that a company with a poorer economy needs, for a more in-depth analysis, see Chapter 28. While the current ratio is of great importance in determining The liquidity of a company, marginal to average, is of little use in determining whether or not a company has a lasting competitive advantage chapter 40 long-term debt something that large companies do not have much long-term debt means debt that matures in any time after one year on the balance sheet and appears under the heading of long-term liabilities if the debt is due within the year it is short-term debt and is placed with the company's current liabilities in Warren's search for a excellent business with a long-term competitive advantage The amount of long-term data the company keeps on its books tells you a lot about the economic nature of the business world.

He has learned that companies that have a durable competitive advantage often have little or no long-term debt on their balance sheets; this is because these companies are so profitable that they are self-sufficient. -finance when they need to expand the business or make acquisitions so that it is never necessary to borrow large sums of money. One of the ways to help us identify the exceptional business is to check how much long-term debt it has in its portfolio. balance sheet We are not only interested in the current year we want to see the long-term debt load that the company has been carrying for the last 10 years if there have been 10 years of operations with little or no long-term debt in According to the balance sheet of the company, it is a good bet that the company has some type of strong competitive advantage that works in its favor.

Warren's historical purchases indicate that in any given year the company should have enough annual net earnings to pay off all of its long-term debt. Within a three- or four-year earnings period, the holders of long-term competitive advantages, Coca-Cola and Moody's, could pay off all of their long-term debt in a single year, and the Wrigley and the Washington Post companies can do so in Two, but companies like GM or Ford in the highly competitive auto industry could spend every penny of the net profits they have made over the last 10 years and still not pay off the enormous amount of long-term debt they have on their balance sheets.

The bottom line here is that companies that have enough purchasing power to pay off their long-term debt in less than three or four years are good candidates in our search for a great business with a long-term competitive advantage, but keep in mind that these Companies are very profitable and have little or no debt. are often the target of leveraged buyouts - this is where the buyer borrows large amounts of money against the company's cash flow to finance the purchase, after the leveraged buyout the business is saddled with large amounts of debt , this was the case with the RJR Nabisco purchase in the late 1980s, if everything else indicates that the company in question is a company with a durable competitive advantage but has a ton of debt on its balance sheet, a leveraged buyout may have created debt in cases like these company bonds are often the best bet since the company's earning power will be focused on paying down the debt and not on growing the company the rule here is simple little or none Long-term debt often means a good long-term bet Chapter 41 Deferred income tax Minority interests and other liabilities Deferred income tax is a tax that is owed but has not been paid This figure tells us little about whether the A balance sheet is much more interesting when the company acquires the shares of another company, it accounts for the price it paid for the shares as an asset in long-term investments, but when it acquires more of eighty percent of the shares of a company, the entire balance sheet of the acquired company can change in its balance sheet the same happens with the income statement, an example of the acquisition by Berkshire of the 90 of Nebraska Furniture mart Because it acquired more than 80 percent of NFM, Berkshire could account for 100 percent of NFM's revenue on Berkshire's income statement and could add 100 percent of NFM's assets and liabilities to its balance sheet.

What the entry of minority interests represents is the value of the 10 percent of NFM that Berkshire does not own. This appears as a liability to balance the equation, since Berkshire recorded 100 percent of NFM's assets. and liabilities even though it owns only 90 percent of nfm. So what does this have to do with identifying a company with a lasting competitive advantage? It's not much, but it's interesting to know what matters and what doesn't in our search for the company with a lasting competitive advantage. Other liabilities are a general category into which companies group their various debts. includes liabilities such as judgments against the company non-current profits interest on tax liabilities unpaid fines and derivative instruments none of these help us in our quest for lasting competitive advantage chapter 42 total liabilities and the debt-to-equity ratio total liabilities is the sum of All liabilities of the company is an important number that can be used to give us the debt-to-equity ratio which with a slight modification can be used to help us identify whether or not a company has a lasting competitive advantage.

The debt-to-equity ratio has historically been used to help us identify whether or not a company is using debt to finance its operations or capital, which includes retained earnings withthose that the company has. A durable competitive advantage will use its purchasing power to finance its operations and should therefore, in theory, show a higher level of shareholders' equity and a lower level of total liabilities. The company without a competitive advantage will be using debt to finance its operations and, therefore, should show just the opposite: a lower level of shareholders' equity and a higher level of total liabilities. The equation is debt-to-equity ratio equals total liabilities divided by equity.

The problem with using the debt-to-equity ratio as an identifier is that the economics of companies. with a durable competitive advantage are so large that they don't need a lot of retained earnings on their balance sheets to get the job done; In some cases, they do not need them due to their great purchasing power; They will often spend their money accumulated retained capital earnings by buying back their shares, which decreases their retained capital earnings base which in turn increases their debt-to-equity ratio often to the point that their debt-to-equity ratio looks like that of a mediocre company without a lasting competitive advantage.

Moody's a Warren favorite is a prime example of this phenomenon. It has such excellent economics in its favor that it does not need to maintain any equity. In fact, it spent all of its shareholders' equity to buy back its shares. It literally has negative shareholders' equity. It means that its debt-to-equity ratio is more like that of GM, a company without a durable competitive advantage and negative net worth, than that of Coca-Cola, a company with a durable competitive advantage; However, if we add back to Moody's shareholders' equity the value of all treasury shares that Moody has acquired through share repurchases, then Moody's debt-to-equity ratio falls to 0.63 in line with the adjusted ratio. of Coca-Cola treasury shares of 0.51 gm still has negative net worth even with the addition of its treasury value. stocks that are nonexistent because GM doesn't have the money to buy back its shares, it's easy to see the contrast between companies with a durable competitive advantage and those that don't when we look at the adjusted debt-to-equity ratio of treasury stocks.

The holder of the durable competitive advantage, Procter Gamble, has an adjusted ratio of 0.71, while Wrigley has a ratio of 0.68, meaning that for every dollar of shareholders' equity Wrigley has, it also has 68 cents in debt, in contrast to png and wrigley with goodyear tires, which has an adjusted ratio of 4.35 or Ford which has an adjusted ratio of 38. This means that for every dollar of shareholders' equity that Ford has it also has 38 dollars in debt which is equivalent to $7.2 billion in equity and $275 billion in debt with financial institutions such as banks. The ratios, on average, tend to be much higher than those of their manufacturing cousins.

Banks borrow huge amounts of money and then lend it back, making money on the spread between what they paid for the money and what they can lend it for this purpose. to a tremendous amount of liabilities that are offset by a tremendous amount of assets, on average the large American monetary banks have ten dollars in liabilities for every dollar of shareholders' equity they keep on their books, this is what Warren means when He says that banks are highly leveraged operations, however, there are exceptions and one of them is Warren's long-time favorite Bank M and T. m t has a ratio of 7.7, which reflects the more conservative credit practices of his administration, the simple rule here is that, unless we are dealing with a financial bank. institution whenever we see an adjusted debt-to-equity ratio below 0.80, the lower the better, there is a good chance that the company in question will have the coveted lasting competitive advantage that we are looking for and find what one is looking for It is always a good thing, especially if one is looking to get rich, chapter 43, book value of shareholders' equity, when you subtract all your liabilities from all your assets, you get your net worth.

If you take a company's total assets and subtract its total liabilities, you get the company's net worth, which is. Also known as shareholders' equity or book value of the company, this is the amount of money that the shareholders who own the company initially invested and left in the business to keep it running. Stockholders' equity is accounted for under the headings of stockholders' equity, which includes paid-up preferred and common stock, and retained earnings add up to total liabilities and total stockholders' equity, yielding a sum that must be equal to total assets, for That's called the balance sheet.

Both sides balance why stockholders' equity is an important number for us. which allows us to calculate return on stockholders' equity, which is one of the ways we determine whether or not the company in question has a long-term competitive advantage in its favor, let's take a look at Chapter 44 Additional Paid Common and Preferred Stock. Capital A company can raise new capital by selling bonds or stocks to the public. The money raised by selling bonds must be repaid at some point in the future. It is borrowed money, but when the company raises money by selling common or preferred stock, it is called capital. the public never has to be returned this money belongs to the company forever to do with it as you please the common stock represents the ownership of the company the owners of common stock are the owners of the company and have the right to elect a board board of directors who in turn will hire a CEO to manage the company, common shareholders receive dividends if the board of directors votes to pay them and if the entire company is sold, it is the common shareholders who take all the loot, there is a second class of capital called preferred.

Preferred stock shareholders do not have voting rights, but they are entitled to a fixed or adjustable dividend that must be paid before common stock owners receive a dividend. Preferred shareholders also have priority over common shareholders in the event the company goes bankrupt. From a balance sheet perspective, preferred and common shares are carried on the books at their face value and any money in excess of the face value that was paid when the company sold the shares will be accounted for as paid-in capital, so if the company shares have a par value of 100 per share and he sold them to the public for one hundred and twenty dollars per share, one hundred dollars per share will be accounted for as preferred stock and twenty dollars per share will be accounted for as paid-in capital.

The same applies to common stock with, say, a face value of one dollar per share, if it is sold to the public at ten dollars per share, it will be carried on the balance sheet as one dollar per share as common stock and nine dollars per share poorly paid. In equity, the strange thing about preferred stock is that companies that have a durable competitive advantage tend not to have any, this is partly because they don't tend to have any debt, they make so much money that they are self-funded, and while Preferred stock is technically equity in the sense that the original money received by the company never has to be repaid, it functions like debt in the sense that dividends must be paid, but unlike interest paid on debt, which is deductible from pre-tax income, dividends paid on preferred stock. are not deductible, which tends to make issuance of preferred stock very expensive money because it is expensive money, companies like to stay away from it if they can, so one of the markers we look for in our search for a company with a durable competitive advantage is the absence of preferred stock in its capital structure chapter 45 war of secretly retained earnings to become super rich at the end of the day the net profits of a company can be paid out as dividends or used to buy back the shares of the company or can be retained to keep the business grows when they are retained in the business, they are added to an account on the balance sheet under stockholders' equity called retained earnings, if the earnings are retained and used profitably, they can greatly improve measure the long-term economic outlook of the business.

It was Warren's policy of retaining 100 percent of Berkshire's net earnings that helped boost shareholders' equity from $19,000 per share in 1965 to $78,000 per share in 2007. To find the annual net earnings Coca-Cola had net profits after tax of $5.9 billion and paid out $3.1 billion in dividends and share buybacks, giving the company approximately $2.8 billion in profits that were added to the retained earnings fund. Retained earnings are a cumulative number, which means that each year's new retained earnings are added to the total accumulated retained earnings of In the same way, every previous year, if the company loses money, the loss is subtracted from what the company has accumulated in the past.

If the company loses more money than it has accumulated, the retained earnings number will appear as the negative of all numbers on a balance sheet. which can help us determine whether the company has a lasting competitive advantage. This is one of the most important ones. It is important because if a company is not making additions to its retained earnings, it is not increasing its net worth. It's unlikely that it's worth making any of us super rich in the long run. Simply put, a company's retained earnings growth rate is a good indicator of whether or not it is benefiting from having a durable competitive advantage.

Let's take a look at some of Warren's claims. favorite companies with a durable competitive advantage Coca-Cola has been growing its pool of retained earnings over the past five years at an annual rate of 7.9 percent Wrigley at a very chewy 10.9 percent Burlington Northern Santa Fe Railroad at a steaming 15.6 percent, anheuser-busch at a frothy 6.4 percent, Well Fargo at a very profitable 14.2 percent and Warren's own Berkshire Hathaway at an outstanding 23. Not all of the growth in retained earnings was due to an incremental increase in sales of existing products. Part of this is due to acquisitions of other businesses. When two companies merge, their retained earnings funds are pooled, creating an even larger fund.

For example, Procter and Gamble in 2005 saw its retained earnings jump from $13 billion to $31 billion when it merged with the Gillette company. Even more interesting is the fact that both general motors and microsoft show negative retained earnings general motors shows a negative number because of the poor economy of the auto business causing the company to lose billions microsoft shows a negative number because it decided that its motor The economy is so powerful that it does not need to retain the huge amount of capital it has raised over the years and has instead chosen to spend its accumulated retained earnings and more on share buybacks and dividend payments to its shareholders.

One of the big secrets to Warren's success with Berkshire Hathaway is that he stopped his dividend payments the day he took control of the company, this allowed 100% of the company's annual net profits to be added to the pool of retained earnings as that opportunities appeared. He invested the company's retained earnings into businesses that made even more money and all that money was added back to the retained earnings. profit pool and eventually invested in even more money-making trades as time went on. Berkshire's growing retained earnings pool increased its ability to make more and more money from 1965 to 2007.

Berkshire's growing retained earnings pool helped boost its pretax earnings from four dollars a share in 1965 to $13,023 per share. stock in 2007, which equates to an average annual growth rate of about 21. The theory is simple, the more earnings a company retains, the faster its pool of retained earnings grows, which in turn will increase the growth rate. To make future profits, the problem is, of course, that you have to keep buying companies that have a lasting competitive advantage, which is exactly what Warren has done with Berkshire Hathaway. Berkshire is like a goose that keeps laying not only golden eggs, but every single one of those golden eggs.

Another goose hatches with the golden touch and those golden geese lay even more golden eggs Warren has discovered that if you keep this process up long enough you will eventually be able to start counting your net worth in terms of billions instead of just millions. Chapter 46 Treasury Stock Warren likes to see this on the balance sheet. What I knowKnown as treasury shares in the United States known as treasury shares in the United Kingdom. When a company buys back its own shares, it can do two things with them: it can cancel them or it can keep them with the possibility of reissuing them later.

If you cancel them, the shares cease to exist, but if you keep them with the possibility of reissuing them later, they are recorded in the balance sheet in equity. net as treasury shares in portfolio Since treasury shares do not have voting rights nor do they receive dividends and, although they are possibly an asset, they are recorded on the balance sheet with a negative value because they represent a reduction in share capital, companies with a competitive advantage Durable because of their great economy they tend to have a lot of free cash that they can spend on buying back their shares, so one of the distinguishing characteristics of a company with a durable competitive advantage is the presence of treasury shares on the balance sheet.

There are several other financial dynamics to consider with respect to treasury stocks. One is that when a company buys its own shares and holds them as treasury shares, it is effectively decreasing the company's capital, which increases the company's return on shareholders' equity, since a high return on equity of shareholders is a sign of a lasting competitive advantage that it is good to know whether high returns on equity are generated by financial engineering or exceptional business economics or due to a combination of both to see which turns the negative value of the own shares in a positive number and adds it to shareholders' equity. subtract it, then divide the company's net profits by the new total shareholders' equity, this will give us the company's return on equity minus the effects of financial engineering also in the United States to determine whether it applies or not the tax on personal holding companies.

Treasury shares are not. part of the pool of shares outstanding when it comes to determining control of the company, the unscrupulous guys will represent to the IRS that they only own 49 of all the shares outstanding, but if you subtract the shares in treasury as the law says, they should actually control in excess of 50 percent, which gives them control of the business and potentially makes them subject to personal holding company tax. Let's leave this chapter with a simple rule: the presence of treasury shares on the balance sheet and a history of share buybacks are good indicators. That the company in question has a durable competitive advantage that works in its favor Chapter 47 Return on Stockholders' Equity Part 1.

Stockholders' equity is equal to the company's total assets minus its total liabilities, which happen to be equal to the total sums of common and preferred shares plus paid shares - in capital plus retained earnings minus treasury shares, shareholders' capital has three sources: one is the capital that was originally obtained by selling common and preferred shares to the public, the second is any subsequent sale of common and preferred shares to the public after the company is in operation and The third and most important for us is the accumulation of retained earnings, since all the capital belongs to the company and since the company belongs to the shareholders common stock, the capital actually belongs to the common shareholders, which is why it is now called stockholders' capital.

As shareholders of a company, we would be very interested in how well management does in allocating our money so that we can earn even more. If they are bad at it, we won't be very happy and might even sell our shares and put our money elsewhere. but if they are really good at it, we might even buy more shares of the company along with everyone else who is impressed with management's ability to make good profitable use of shareholders' equity. To this end, financial analysts developed the return on equity equation to test management efficiency. When allocating shareholders' money, this is an equation that Warren places great importance on in his pursuit of a company with a lasting competitive advantage and is the subject of our next chapter, Chapter 48, Return on Shareholders' Equity, Part 2.

Calculation of net profits divided by shareholders. Equity equals return on stockholders' equity. What Warren discovered is that companies that benefit from a durable or long-term competitive advantage show above-average returns on equity. Warren's favorite Coke shows a return on equity of 30 percent. Wrigley hits 24 Hershey's earns a delicious 33 percent and Pepsi measures 34 percent. Move into a highly competitive business like airlines, where no company has a sustainable competitive advantage and return on equity sinks dramatically. United Airlines in a year in which it makes money reaches 15 percent and American Airlines earns 4 percent. Delta Airlines and Northwest make nothing because they don't make money.

High returns on equity mean the company is making good use of the earnings it retains over time. The returns on equity will add up and increase the underlying value of the business, which over time will be recognized by the stock market through a rising price of the company's shares. Keep in mind that some companies are so profitable that they don't need to retain any profits. then they pay them all to the shareholders. In these cases, we will sometimes see a negative number for shareholders' equity. The danger here is that insolvent companies will also show a negative number for shareholders' equity.

If the company shows a long history of strong net profits, but shows negative shareholders' equity, it is probably a company with a durable competitive advantage. If the company shows both a negative shareholders' equity like a history of negative net profits, we're probably dealing with a mediocre business that's getting hammered by the competition, so here's the rule: high returns on shareholders' equity means coming to play low returns on equity. from shareholders means staying away, got it, let's move on to chapter 49 the problem with leverage and the tricks it can play on you leverage is the use of debt to increase the company's profits the company borrows $100 million seven percent and put that money to work where you earn 12, this means you are earning 5 above your capital costs, the result is that you take $5 million to the bottom line, increasing profits and performance.

Regarding capital, the problem with leverage is that it can make the company appear to have some kind of competitive advantage when in reality it is just using large amounts of debt. Wall Street investment banks are famous for using large amounts of leverage to generate profits. In their case, they borrow $100 billion at, say, six percent and then lend it out at seven percent, which means they are earning one percent of the $100 billion, which is equivalent to billion dollars if those billion dollars appear year after year. year creates the appearance of some kind of lasting competitive advantage, even if there isn't one, the problem is that while the investment bank appears to have consistency in its income stream, the actual source sending you payments may interest rate cannot keep up with payments, this happened in the recent subprime lending crisis that cost banks hundreds of billions of dollars, they borrowed billions at six percent and lent them at eight percent to subprime homebuyers, which made them a lot of money, but when the economy began to decline subprime homebuyers began defaulting on their mortgages, which meant these subprime borrowers stopped making interest payments.

High risk investors had no durable source of income, which ultimately meant that investment banks did not have one either. When evaluating the quality and durability of a company's competitive advantage, Warren has learned to avoid companies that use a lot of leverage to generate profits in the short term; They seem to be the goose that lays the golden eggs, but at the end of the day they are not the cash flow. statement 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 does not require capital Warren Buffett chapter 50 the cash flow statement where Warren goes to find the cash most companies use what which is called the accrual method of accounting, as opposed to the cash method.

With the accrual method, sales are accounted for when goods walk out the door, even if it takes years for the buyer to pay for them. With the cash method, sales are only accounted for when the cash arrives because almost all businesses extend some type of credit to their buyers. Companies have found it more advantageous to use the accrual method of accounting, which allows them to account for credit sales as revenue in accounts receivable on the income statement, since the accrual method of accounting allows credit sales to be accounted for as income, it has become necessary for companies to keep separate records of the actual cash coming in and going out of the business.

For this purpose, accountants created the cash flow statement. A company may have a large amount of cash coming in through the sale of shares. or bonds and still not be profitable. Similarly, a company can be profitable with a lot of credit sales and not much cash coming in on the cash flow statement, which will tell us only if the company is bringing in more cash than it is spending positive cash. Cash flow statements are like income statements in that they always cover a certain period of time. The company's accountants generate one every three months and for the fiscal year the cash flow statement breaks down.

In three sections, first is cash flow from operating activities. This area starts with net income and then adds back depreciation and amortization. Although these are real expenses from an accounting standpoint, they do not consume cash because they represent cash that was consumed years ago so we end up with the total cash from operating activities, next up is the cash flow from investing operations. This area includes an entry for all capital expenditures incurred for that accounting period. Capital expenditures are always a negative number because it is an expenditure that causes a depletion of cash. Also included in this category is the total of other investment cash flow items, which sums up all the cash that is spent and obtained from the buying and selling of income-producing assets.

If more cash is spent than is brought in, it is negative. number if more cash is brought in than is spent, it is a positive number. Both entries are added to give us the total cash from investing activities. Finally, there is the section on cash flow from financial activities, which measures cash coming in and going out. of a company due to financing activities this includes all cash outflows for the payment of dividends also includes the buying and selling of shares in the company when the company sells shares to finance a new plant cash flows to the company when the company repurchase your shares the cash flows out of the company, the same goes for bonds, you sell a bond and the cash flows to repurchase a bond and the cash flows out, these three inputs are added to provide the total cash of financial activities now if we add the total. cash from operating activities with cash for investing activities together with total cash from financing activities we get the net change in cash of the company.

What Warren has discovered is that some of the information found in a company's cash flow statement can be very useful in helping us determine. Whether or not the company in question is benefiting from having a durable competitive advantage, so let's roll up our sleeves and dig into the cash flow statement to see what Warren sees as he searches for the company that will make him his next Chapter 51 capital. millions. Not having expenses is one of the secrets to getting rich. Capital expenditures are expenditures of cash or its equivalent on assets that are more permanent in nature and held for more than one year, such as property, plant and equipment.

They also include expenses for intangibles like patents, basically. They are assets that are expensed over a period of time greater than one year through depreciation or amortization. Capital expenditures are recorded in the cash flow statement under investing operations. Purchasing a new truck for your business is a capital expense. The value of the truck will be charged to expenses. through depreciation over its life, say six years, but the gasoline used in the truck is a current expense and the full price is deducted from income during the current yearWhen it comes to making capital expenditures, not all companies are created equal.

Many companies must make enormous capital expenditures just to stay in business. If capital expenditures remain high for several years, they can begin to have a profound impact on profits Warren. He has said that this is the reason why they never invested in telephone companies. Huge capital outlays in building communication networks greatly hamper their long-term economics. As a general rule, a company with a durable competitive advantage uses a smaller portion of its profits for capital expenditures for continuing operations than those without a competitive advantage. advantage, let's look at a couple of examples, Coca-Cola, a long time Warren favorite, over the last 10 years earned a total of 20.21 cents per share, while only using four dollars and one cent per share or 19 of its total earnings for capital expenditures for the In the same period, Moody's, a company that Warren has identified as having a durable competitive advantage, earned 14.24 cents per share over the past 10 years, while using a minuscule 84 cents per share or five percent of its total earnings for capital expenditures.

Compare Coca-Cola and Moody's to GM, which over the past 10 years earned a total of 31.64 cents per share after subtracting losses and spent a whopping $140 and 42 cents per share on capital expenditures or the maker of Goodyear tires, which over the past 10 years earned a total of three dollars and 67 cents per share. stock after subtracting losses and had total capital expenditures of 34 dollars and 88 cents per share if GM used 444 more for capital expenditures than it earned and Goodyear used 950 percent where all that extra money came from came from bank loans and selling tons of new debt to the public, such actions add more debt to the balance sheets of these companies, which increases the amount of money they spend on interest payments, which is never a good thing.

Both Coke and Moody's, however, have enough excess income to have share repurchase programs that reduce the number of shares outstanding while reducing long-term debt or keeping it low. Both actions are very positive for Warren and both helped him identify Coca-Cola and Moody's as companies with a lasting competitive advantage that works in his favor when we look. For capital expenditures relative to net profits, we simply add up a company's total capital expenditures over a 10-year period and compare the figure to the company's total net profits over the same 10-year period, reason why which we analyze a period of 10 years. is that it gives us a very good long-term perspective of what is happening with the business, a historically lasting competitive advantage.

Companies used a much smaller percentage of their net income for capital expenditures. For example, Wrigley annually uses approximately 49 percent of its net income for capital expenditures. Altria uses approximately 20 percent of Procter Gamble, 28 percent of Pepsico, 36 percent of American Express, 23 percent of Coca-Cola, 19 and five percent of Moody's. Warren has found that if a company historically uses 50 percent or less of its annual net profits for capital expenditures it is a good place to look for a lasting competitive advantage if it consistently uses less than 25 percent of its net profits for capital expenditures, That scenario occurs more than likely because the company has a durable competitive advantage working in its favor and having a durable competitive advantage working. in our favor is what it's all about chapter 52 stock buybacks warren's tax-free way to increase shareholder wealth in the cash flow statement found at www.tantor.com keyword financial the company examined paid dividends of $3.149 billion, repurchased $219 million of its stock and sold $4.341 billion of new debt, all giving the company a net addition of $973 million in cash from financing activities.

Companies that have a durable competitive advantage working in their favor make a ton of money, which creates the lovely problem of having to do something with it, if they don't want to sit around or can't reinvest it in the existing business or find a new one. business to invest in, they can pay it as dividends to their shareholders. or use it to buy back shares, since shareholders have to pay income taxes on the dividends. Warren has never been big on using dividends to increase shareholder wealth. This doesn't make anyone happy. A better trick that Warren loves is to use some of the excess. money that the company is wasting to buy back the company's shares, this reduces the number of shares outstanding, which increases the remaining shareholders' interest in the company and increases the company's earnings per share, which eventually causes For example, if the company earned $10 million and had one million shares outstanding, it would have earnings of ten dollars per share.

If we increase the number of shares outstanding to two million, the Earnings per share will fall to five dollars per share, in the same way if we decrease the number of shares outstanding to five hundred thousand we will increase earnings per share to twenty dollars per share. More shares outstanding means lower earnings per share and fewer shares outstanding mean higher earnings per share, so if the company buys back its own shares it can increase its earnings per share figure, although actual net earnings do not increase, the best part is that there is an increase in shareholders' wealth on which they do not have to pay taxes until they sell their shares.

Think of it as the gift that keeps them going. Warren is a big fan of this piece of financial engineering that pressures the board of directors of all the great companies he invests in to buy back shares instead of raising the dividend. You used it with geico and you are still using it with the washington post company to find out if a company is buying back its stock, go to the cash flow statement and look under cash from investing activities there you will find a title titled withdrawal of issue of net shares, this entry excludes the sale and buyback of the company's shares, if the company buys back its shares year after year, it is a good bet that this is a lasting competitive advantage that is generating all the extra money that allows it to do so ;

In other words, one of the indicators of the presence of a durable competitive advantage is a history of the company buying back or withdrawing its shares valuing the company with a durable competitive advantage I look for businesses where I believe I can predict what they will be like 10 to 10 years from now. 15 years old, take the Wrigley method of chewing gum I don't think the Internet is going to change the way people chew gum Warren Buffett Chapter 53 Warren's revolutionary idea about stock bonuses and how it has made him super rich in the late 1990s In the 1980s, Warren gave a talk at Columbia University about how businesses work. with a durable competitive advantage show such strength and predictability in earnings growth that the growth turns their shares into a kind of equity bond with an ever-increasing coupon or interest payment.

The bond is the equity capital of the shares. of the company and the coupon interest payment is the previous payment of the company. Tax profits are not the dividends the company pays, but rather the actual pre-tax profits of the company. This is how Warren buys an entire company. He looks at its pre-tax earnings and asks if the purchase is a good deal relative to economic strength. of the underlying economics of the company and the asking price for the business, uses the same reasoning when purchasing a partial stake in a company through the stock market, which draws Warren to the conceptual conversion of a company's shares. company in capital bonds is that durable goods The competitive advantage of the business creates an underlying economics that is so strong that it causes a continuous increase in the company's profits.

With this increase in earnings comes an eventual increase in the company's stock price as the stock market recognizes the increase in the underlying value of the company. Therefore, the company risks being repetitive by warning that the shares of a company with a durable competitive advantage are the equivalent of stock bonds and the company's pre-tax earnings are the equivalent of a bond coupon. normal or to the payment of interest, but instead of the bond coupon. or the interest rate is fixed, it continues to increase year after year, which naturally increases the value of the stock bonds year after year.

This is what happens when Warren buys a company with a lasting competitive advantage. Earnings per share continue to increase over time, whether through further business expansion. of operations the purchase of new businesses or the repurchase of shares with money that accumulates in the coffers of the company with the increase in profits comes a corresponding increase in the return that Warren obtains from his original investment in the capital bond let's look at a example to see how his theory works In the late 1980s, Warren began buying Coca-Cola stock at an average price of 6.50 cents per share, against pretax earnings of 70 cents per share, which It equates to after-tax earnings of 46 cents per share historically for Coca.

Coca-Cola's profits had been growing at an annual rate of about 15 percent. Since Warren could argue that she just bought a Coca-Cola stock bond that is paying an initial pre-tax interest rate of 10.7 on her investment of 6.50, she could also argue that that yield would increase over time at a projected annual rate of 15 percent understand that, unlike the value based on grams, investors Warren is not saying that Coca-Cola is worth sixty dollars and is trading at forty dollars a share, therefore it is undervalued which is. What he was saying was that at six dollars and fifty cents a share he was offered a relatively risk-free initial pretax rate of return of ten.seven percent, which he expected to increase over the next twenty years at an annual rate of about 15 percent. percent. then questioned whether this was an attractive investment, given the risk and return rate of other investments, for investors in securities based on grams a pre-tax rate of return of 10.7 percent and growth of 15 percent per year would not be interesting since they are only interested in the stock market price and regardless of what happens with the business, he has no intention of holding the investment for more than a couple of years, but Warren, who plans to own The capital bond for 20 years or more is the investment of your dreams, why?

It is his dream investment because with each passing year the return on his initial investment actually increases and in recent years the numbers really start to form a pyramid. Consider that Warren's initial investment in the Washington Postal Company cost her six dollars and 36 cents per share over 34 years. Later in 2007, the media company is earning $54 before taxes per share, which equates to an after-tax yield of thirty-four dollars per share, giving Warren's Washington Post stock bonds a current pre-tax yield of 849 percent, which is equivalent to an after-tax yield of 534 and you were wondering how Warren got so rich, so how did Warren do with his Coca-Cola stock bonuses?

In 2007, Coca-Cola's earnings had grown at an annual rate of about 9.35 percent to 3.96 cents per share, equivalent to 2.57 cents per share after taxes, meaning Warren can argue that your coke stock bonds are now paying you a pre-tax yield of 3.96 per share on your original investment of 6.50 per share, which equates to a current pre-tax yield of 60 percent and a current after-tax rate of 40 percent. The stock market seeing this performance over time will eventually revalue Warren's stock bonds to reflect this increase in value. Consider this with long-term corporate interest rates of about 6.5 percent in 2007. Bond stocks with a pre-tax earnings interest payment of fifty-four dollars were worth about eight hundred and thirty dollars per bond stock share that year.

Fifty-four dollars divided by point zero six five equals eight hundred and thirty dollars during 2007. Warren's Washington Post stock bond shares traded in a range of between seven hundred and twenty-six dollars and eight hundred and eighty-five dollars per share, which is in line with the capitalized value of stock bonds of eight hundred and thirty dollars per share, we can witness the same phenomenon of revaluation of thestock market with Warren's coke. stock bonds in 2007 earned 3.96 cents before taxes per share of stock bonds, which is equivalent to 2.57 cents after taxes per share of stock bonds capitalized at the corporate interest rate of 6.5 percent.

Koch's 3.96 pre-tax earnings are worth about $60 per share. A 3.96 bond share divided by five equals sixty dollars. During two thousand and seven, the stock market valued Coca-Cola at between forty-five and sixty dollars. and four dollars per share. One of the reasons the stock market eventually follows the rise of the underlying values ​​of these companies is that their earnings are so consistent that they are an open invitation to a leveraged buyout if a company has little debt. and a strong earnings record and its stock price falls low enough, another company will come in and buy it by financing the purchase with the acquired company's earnings, so when interest rates fall the company's earnings are worth more because they will back more debt, which makes the company's stock worth more and when interest rates rise earnings are worth less because they will back up less debt, this makes the company's stock worth less what Warren has learned is that if If you buy a company with a durable competitive advantage, the stock market will eventually price the company's bond stock at a level that reflects the value of its earnings relative to the long-term corporate bond yield.

Yes, some days the stock market is bearish and on others it is filled with wild optimism, but in the end it is long-term interest rates that determine the economic reality of the value of long-term investments. Chapter 54 The Increasing Returns Created by Durable Competitive Advantage Capital have increased over time in 1998, Moody's reported after-tax earnings of 41 cents per share in 2007. Moody's after-tax earnings had increased to 2.58 cents per share. Warren paid 10.38 cents per share. for their Moody's stock bonds and today are earning an after-tax yield of 24, which is equivalent to a pre-tax yield of 38 percent in 1998. American Express had after-tax earnings of 1.54 cents per share in By 2008 their after-tax earnings had risen to 3.39 cents per share Warren paid 8.48 cents per share for his American Express stock bonds, meaning they are currently generating an after-tax rate of return of 40, which which equates to a pre-tax rate of return of 61 percent, Warren's long-favorite proctor bet.

It made after-tax earnings of 1.28 cents per share in 1998. In 2007 it had after-tax earnings of three dollars and thirty-one cents per share. Warren paid ten dollars and fifteen cents a share for her Procter and Gamble stock bonds that are now yielding an after-tax profit. 32 percent, which equates to a pre-tax return of 49 percent; c's Candy Warren bought the entire company for $25 million in 1972. In 2007 it had pre-tax profits of $82 million, which means its C-share bonuses are now producing an annual pre-tax return of 328 percent. percent on its original investment with all of these companies, its enduring competitive advantage caused its profits to increase year after year, which in turn increased the underlying value of the business.

Yes, the stock market can take its own time to recognize this. This increase, but it will happen eventually and Warren has counted on that happening many times. Chapter 55 More Ways to Value a Company with a Durable Competitive Advantage As noted above In 1987, Warren began purchasing Coca-Cola stock for an average price of six dollars. and fifty cents per share versus pre-tax earnings of 70 cents per share, this equates to after-tax earnings of 46 cents per share, historically Coca-Cola's earnings had been growing at an annual rate of about 10 percent . If you had just purchased a Coca-Cola stock bond paying an initial pre-tax interest rate of 10.7 percent on your 6.50 investment, you could also argue that that pre-tax yield would increase over time at a rate Coca-Cola's projected 10 percent annual average. annual rate of earnings growth for the 10 years to 1987.

If in 1987 you had projected earnings growth of 10 percent forward, you could have argued that by 2007 Coca-Cola would have pretax earnings per share of 4 .35 cents and then tax earnings of 2.82 cents per share, this would mean that by 2007 your before-tax yield on your Coca-Cola bonds would grow to 66 percent, which is equivalent to an after-tax yield of 43. So what was a 66 percent pre-tax return on a 6.50 stock bond in 2007 with a value in 1987. It depends on what discount rate we use, if we use seven percent, which is correct about what long-term rates were back then, we get a discounted value of about 17 percent, multiply 17 percent by the six dollars and fifty cents per share you were paying and we would get one dollar and ten cents per share we multiply one dollar and ten cents by Coca-Cola's 1987 p and e of 14 and we get 15 dollars and 40 cents per share, so Warren could have argued in 1987 that he was buying a stock bond for six dollars and 50 cents per share and that if you held it for 20 years its intrinsic value in 1987 would actually be 15 and 40 cents per share in 2007, when Coca-Cola pre-tax profits had grown at an annual rate of 9.35 percent to 3 .96 cents per share, which equates to 2.57 cents per share after taxes.

This means Warren can argue that her Coca-Cola stock bonds are now paying her a pre-tax return of three. dollars and 96 cents per share on their original investment of six dollars and fifty cents per share, which equates to a current pre-tax return of sixty percent and an after-tax return of forty percent; In 2007, the stock market valued Warren's stock bonuses at between forty-five dollars and sixty-four dollars per share. In 2007, Coca-Cola earned $3.96 before taxes per equity bond share, which was equivalent to 2.57 cents after tax per capitalized bond share at the 2007 corporate interest rate of 6.5 percent before Coca-Cola. -tax earnings of three dollars and ninety-six cents per share are worth approximately sixty dollars per share of capital bond three dollars and ninety-six cents divided by point zero six five equals sixty dollars, this is in line with the value of stock market in 2007 of between forty-five dollars and sixty-four dollars per share, with the market valuing Warren's Coca-Cola bonds at sixty-four dollars per share in 2007.

Warren could estimate that he has been earning a rate of 12.11 compounded annual tax-deferred return on your original investment. consider it as a bond that paid an annual rate of return of 12.11 with no taxes on the interest earned, not only that you have to reinvest all those interest payments in more bonds that paid 12.11 percent, yes, someday you will have You have to pay taxes when you sell. your stock bonuses, but if you don't sell them, you will continue to earn 12.11 tax free year after year after year. Don't believe it. Consider that Warren has roughly $64 billion in capital gains on her Berkshire shares and has yet to pay out. a penny in taxes, the largest accumulation of private wealth in the history of the world and not a penny paid to the taxman, is there anything better? chapter 56 how warren determines the right time to buy a fantastic business in warren's world the price you pay directly affects the return on your investment because he is treating a company with a lasting competitive advantage as if it were some kind of bond of capital, the higher the price you pay, the lower your initial rate of return and the lower the rate of return on the investment. company earnings in 10 years, let's look at an example: In the late 1980s, Warren began buying Coca-Cola at an average price of 6.50 cents per share, against earnings of 46 cents per share, which in Warren's world it equates to a seven percent initial rate of return.

In 2007, Coca-Cola earned 2.57 cents per share, meaning Warren can argue that her Coca-Cola stock bonus now paid her 2.57 cents per share on her original investment of six dollars and fifty cents. which is equivalent to a performance of thirty-nine. point nine percent, but if you had paid twenty-one dollars per Coca-Cola share in the late 1980s, your initial rate of return would have been 2.2 percent in 2007, this would have grown only to 12 percent, two dollars and 57 cents divided. times 21. equals 12 percent, which is definitely not as attractive a number as 39.9, so the lower the price you pay for a company with a durable competitive advantage, the better off you'll do in the long run, and Warren It has to do with the long term.

However, these companies rarely, if ever, sell at a bargain price from an old-school Grammy perspective. This is why investment managers who follow the value doctrine that Graham preached never own super businesses because for them these businesses are too expensive, so when to buy into them? To begin with, in bear markets, although they may still seem expensive compared to other bear market offerings, in the long run they are actually the best option and sometimes even a company with a long-lasting competitive advantage can make a mistake and make something stupid that will make your shares fall. falling price in the short term I think the new Coke Warren has said that a wonderful buying opportunity can present itself when a large business faces a problem that can be solved only once.

The key here is that the problem has a solution. When do you want to stay away from these super problems? companies at the height of bull markets when these super companies trade at historically high price/earnings ratios, even a company that benefits from having a durable competitive advantage cannot free itself from producing mediocre results for investors if they pay too much price of admission lofty chapter 57 how warren determines it's time to sell in warren's world you would never sell one of these wonderful businesses while maintaining your lasting competitive advantage. The simple reason is that the longer you hold them, the better you will do, even if every time you sell one of these large investments you would be inviting the taxman to the party.

Inviting the tax man to your party too many times makes it very difficult to get super rich. Consider that Warren's company has about $36 billion in capital gains from its investments in companies that have a durable competitive advantage, this is wealth that it has not yet paid a cent in taxes on and, if gets away with it, he never will. Still, there are times when it is advantageous to sell one of these wonderful businesses, the first is when money is needed to make an investment in an even better company at a better price, which happens occasionally; The second is when it appears that the company is going to lose its lasting competitive advantage; this happens periodically, as it does with the newspapers and television stations that both use.

They seemed like fantastic businesses, but then the Internet came along and suddenly the durability of their competitive advantage was called into question. The buying frenzy causes the prices of these fantastic companies to shoot through the roof; In these cases, the current selling price of the company's stock far exceeds the long-term economic realities of the company, and the long-term economic realities of a company are like gravity when stock prices rise to outer limits will eventually bring the stock price back down to earth if they go too high the economics of selling and putting the profits into another investment may outweigh the benefits offered by continued ownership of the business, think of it this way if we can project that The business we own will earn $10 million in the next 20 years and today someone offers us $5 million for the entire company.

Do we accept it if we can only invest the five million dollars at a two percent CAGR? of return probably not, since the $5 million invested today at a two percent compounded annual rate of return would be worth only $7.4 million by year 20. That's not much to spend.us, but if we could earn an 8 Percent CAGR, our $5 million would have grown to $23 million by year 20. Suddenly, selling seems like a good deal, a simple rule is that when we see p and d ratios of 40 or more in these super companies, and this happens occasionally. It may be time to sell, but if we sell in a raging bull market, then we shouldn't go out and buy something else trading at 40 times earnings.

Instead, we should take a break, put our money in US Treasuries, and wait for the next one. bear market because there is always another bear market around the corner waiting to give us the golden opportunity to buy one or more of these incredible businesses with lasting competitive advantages that, in the long run, will make us super super rich, just as it did Warren Buffett.