Warren Buffett – How he Interprets Financial Statements


What Warren Buffet Looks in Companies He invests in
Warren Buffet’s Insights on Financial Statements are the best place to start for regular investors and new financiers. They must go through Buffet’s understanding of Financial Statements when they examine which company to invest in. There is no Warren Buffet’s definite interpretation of financial statements; however, he has given key indicators over time, with regards to what he sees in a firm when he invests his money. Warren Buffett prefers to specific secrets when he considers a company for investment purpose.
Income Statement
Companies with Durable Competitive Advantages: Buffett looks for companies which have durable competitive advantages. He looks for companies which are great performers in their respective fields.

Gross Profit Margins of over 40%: As explained earlier, Gross Profit Margins less than 20% usually tends to sell products which are either commodities or extremely price sensitive. The Gross Profit Margins less than 20% is an indicator of a lack of durable competitive advantage.

Must Spend Less on Selling and General Administration Expenses: Buffett chooses firms which spend less than 30% of their proceeds on SG&A. This illustrates operational brilliance and companies which are the greatest in their fields. This is a great indicator of a great firm.Return on Equity: Buffett recognizes this as one of the most significant measures of a firm’s capability to produce wealth for its shareholders with the passage of time. Buffett has customarily acknowledged a 2% return on equity as being the average for public companies. Above 20% is good, while firms that earn above 30% are greater.
Return on Invested Capital: Buffett examines how retained earnings are being reinvested by the management of the firm.

He also checks how management is able to grow earnings over time with funds earned in the preceding years. He considers firms earning more than 30% on re-invested capital as remarkable and brilliant (Reinvested capitals are financial gains which the firm has earned and reinvests into the business again.)
Must Have an Upward Trend in Net Earnings: Persistent upward trend in the firm’s net earnings, with a consistency of performance over time and predictability in the firm’s earning power. It’s a good indicator of running a business.
Balance Sheet:
Firms with Lower Levels of Debt: Buffett has objectives to find firms with lower levels of debt, and specifically avoids companies which are laced with high-interest expenses. To Warren Buffett, this may be an indicator of a business that functions in a competitive industry or that the business is highly capital intensive.
Cash Balance/Securities: Buffett makes certain that the companies have sufficient securities/cash, which in return ensures whether a business will successfully go through economic downturns or not. This is a great indicator if Business will run or not.
Inventories/Accounts Receivable: Buffett searches for companies, which increase their Inventories and Accounts Receivable at the same pace, which they increase their net earnings, showcasing business efficiency.
Must not Require Repairs and Maintenance: Buffett aims to recognize companies which do not necessarily have to do the repairs and maintenance of their equipment and machines every now and then. These companies do not have a competitive advantage. This is an alarming indicator.
Return on Assets: Firms which generate high returns on their assets display high levels of efficiency.
Takeaway for Investors
When you sit for analyzing different companies for investing, keep in consideration some of the principles that Warren Buffett looks for when interpreting financial statements. Ensure that you are investing in companies which are the finest in class and have a sustainable competitive advantage. Do not judge like most investors, who end up making blunders of investing in average businesses.
‘Price is what you pay, a value is what you get’ – Benjamin Graham


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