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1-Page Summary of Financial Statements

The Divergent Styles of Warren Buffett and His Mentor

In the 1950s, an economist and professional investor named Benjamin Graham served as a mentor to Warren Buffett. Buffett went on to become one of the world’s wealthiest people by applying value investing techniques that he learned from Graham. Value investing is a strategy for buying into companies with low stock prices.

Buffett started his own investment business and altered the Graham method of value investing in several ways. For one, Buffett ignores the 50% rule because sometimes a stock’s price can rise much more than that. He prefers high-quality companies with predictable cash flows over low costs for stocks. He also favors concentrating on a few stocks instead of diversifying his portfolio to increase the odds that moneymaking stocks will offset losers.

Warren Buffett studies the financial statements of companies to find the best ones. He believes that a company’s success is determined by its ability to create and maintain an economic advantage over its rivals.

Three Business Models That Buffett Likes Best

Buffett likes companies that have a unique product or service, are the least expensive provider of their products or services, and can brand themselves. He feels that those three qualities will allow a company to stand out from its competitors.

Buffett is known for his investment in Coca-Cola, which has been one of his most successful investments. Buffett also invested in Moody’s, an agency that rates stocks and bonds; H&R Block Inc., which provides tax preparation services; Wells Fargo & Co., a bank holding company; Walmart Stores Inc., the world’s largest retailer; and Burlington Northern Santa Fe Railway Company (BNSF), one of North America’s leading transportation companies.

Hunting for Value in Financial Statements

Warren Buffett uses three kinds of financial statements to evaluate a company. The first is the income statement, which summarizes revenue and expenses over a period of time. He also looks at the cash flow statement, which accounts for cash provided or consumed by operations, investments and financing activities over a period of time. Finally, he considers the balance sheet that captures the condition of assets and liabilities on one date. For example, when comparing different line items in these statements he subtracts cost from revenue to determine gross profit margin (gross profit divided by revenue), then divides it by revenue to calculate gross profit percentage (gross profit/revenue). A firm that reliably achieves margins of 40% or more probably has a durable competitive advantage.

Operating expenses are important to companies. They cover the costs of running a business, including executive compensation and advertising fees. These operating expenses are very similar to selling, general and administrative (SGA) expenses in financial statements. The main difference is that SGA expense items tend to be more volatile than operating income items. Therefore, it’s more useful to compare them with each other rather than looking at them alone. For example, Buffett likes stable SGA expenses as a percentage of gross profit because they indicate how well the company is doing in its industry relative to others like it. He considers anything under 30% as fantastic since he believes this indicates dominance within an industry by one firm over another firm or firms in that same industry/sector/market space or niche market segmentation category for products and services offered within said sector or niche market segmentation category for products and services offered within said sector