How Does Buffett Quickly Analyze a Stock?#
When Buffett selects stocks, he usually filters companies by analyzing financial statements. In the book "Working with a Tap Dance," when asked about the source of his creativity, he replied: mainly relying on reading, with daily work involving a lot of reading. By reading annual reports and analyzing specific financial indicators, he conducts preliminary screening.
1. Return on Equity#
This indicator measures the efficiency of a company in using capital, commonly calculated as ROE = Net Profit / Average Net Assets. Through the DuPont analysis method, return on equity can be broken down into three elements: ROE = Net Profit Margin * Asset Turnover * Financial Leverage. This indicator can comprehensively reflect the overall operating condition of a company. Buffett believes that the return on equity should be above 15% (the following analysis references the financial reports of Kweichow Moutai for 2023 and 2024).
For example, Kweichow Moutai's return on equity for 2023 and 2024 was 34.19% and 36.02%, respectively, an increase of 2 percentage points. Considering the company holds a large amount of cash that is not effectively utilized, the return on equity excluding cash for 2024 may approach 50%. This means Moutai can recover all invested costs within two years.
2. Gross Margin#
Gross Margin = (Operating Revenue - Operating Costs) / Operating Revenue, directly reflecting the profit space of the product. For example, if a product sells for 100 yuan and costs 40 yuan, the gross margin is 60%. Buffett requires a gross margin above 40%. A high gross margin indicates that the product has unique advantages, a wide economic moat, and strong risk resistance.
In the Chinese liquor industry, gross margins are generally high. Taking Kweichow Moutai as an example, the gross margins for 2023 and 2024 were 92.11% and 92.01%, respectively, a year-on-year decrease of 0.1 percentage points.
3. Net Margin#
Net Margin = Net Profit / Operating Revenue, representing the actual profit after deducting all costs and expenses. If a company has a high gross margin but excessively high management or sales expenses, it will erode profits, leading to an unsatisfactory net margin. Buffett believes that the net margin should be greater than 5%.
For Kweichow Moutai in 2023 and 2024, the net margins were 49.5% and 51.2%, respectively, a year-on-year increase of 1.7 percentage points. This indicates that Moutai's management or sales expenses may have decreased.
The above are three key criteria for Buffett's stock selection, but company analysis also includes other indicators, such as price-to-earnings ratio and differentiation.
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