Warren Buffett’s Financial Statement Rules of Thumb

 

💰 INCOME STATEMENT:

1: Gross Margin
🧮 Equation: Gross Profit / Revenue
👍 Rule: 40% or higher
🤔 Buffetts Logic: Signals the company isn’t competing on price.

2: SGA Margin
🧮 Equation: SGA Expense / Gross Profit
👍 Rule: 30% or lower
🤔 Buffetts Logic: Wide-moat companies don’t need to spend a lot on overhead to operate.

3: RD Margin
🧮 Equation: RD Expense / Gross Profit
👍 Rule: 30% or lower
🤔 Buffetts Logic: RD expenses dont always create value for shareholders.

4: Depreciation Margin
🧮 Equation: Depreciation / Gross Profit
👍 Rule: 10% or lower
🤔 Buffetts Logic: Buffett doesnt like businesses that need to invest in depreciating assets to maintain their competitive advantage.

5: Interest Expense Margin
🧮 Equation: Interest Expense / Operating Income
👍 Rule: 15% or lower
🤔 Buffetts Logic: Great businesses don’t need debt to finance themselves.

6: Income Tax Expenses
🧮 Equation: Taxes Paid / Pre-Tax Income
👍 Rule: Current Corporate Tax Rate
🤔 Buffetts Logic: Great businesses are so profitable that they are forced to pay their full tax load.

7: Net Margin (Profit Margin)
🧮 Equation: Net Income / Sales
👍 Rule: 20% or higher
🤔 Buffetts Logic: Great companies convert 20% or more of their revenue into net income.

8: Earnings Per Share Growth
🧮 Equation: Year 2 EPS / Year 1 EPS
👍 Rule: Positive Growing
🤔 Buffetts Logic: Great companies increase profits every year.

⚖ BALANCE SHEET:

9: Cash Debt
🧮 Equation: Cash Debt
👍 Rule: More cash than debt
🤔 Buffetts Logic: Great companies dont need debt to fund themselves.

10: Cash Debt
🧮 Equation: Cash Debt
👍 Rule: More cash than debt
🤔 Buffetts Logic: Great companies generate lots of cash without needing much debt.

11: Adjusted Debt to Equity
🧮 Equation: Total Liabilities / Shareholder Equity + Treasury Stock
👍 Rule : 0.80
🤔 Buffetts Logic: Great companies finance themselves with equity.

12: Preferred Stock
👍 Rule: None
🤔 Buffetts Logic: Great companies dont need to fund themselves with preferred stock.

13: Retained Earnings
🧮 Equation: Year 1 / Year 2
👍 Rule: Consistent growth
🤔 Buffetts Logic: Great companies grow retained earnings each year.

14: Treasury Stock
👍 Rule: Exists
🤔 Buffetts Logic: Great companies repurchase their stock.

💸 CASH FLOW STATEMENT:

15: Capex Margin
🧮 Equation: Capex / Net Income
👍 Rule: 25%
🤔 Buffetts Logic: Great companies dont need much equipment to generate profits.

Caveats:
1️⃣ There are plenty of exceptions to these rules.
2️⃣ CONSISTENCY IS KEY!

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