How Ordinary People Can Analyze Stocks Like Buffett

How Does Buffett Quickly Analyze a Stock?#

When Buffett selects stocks, he typically filters companies by analyzing financial statements. In the book "Working with a Tap Dance," he mentioned that when asked about his source of inspiration, he replied, "I read. My daily work is reading." By reading annual reports and analyzing specific financial indicators, he conducts preliminary screening.

1. Return on Equity (ROE)#

This indicator reflects a company's ability to utilize capital, commonly calculated as ROE = Net Profit / Average Net Assets. Through the DuPont analysis, ROE can be broken down into three components: ROE = Net Profit Margin × Asset Turnover × Financial Leverage. It comprehensively reflects the operational status of a business, and Buffett requires a ROE higher than 15% (the following analysis references the 2023 and 2024 financial reports of Kweichow Moutai).

For example, Kweichow Moutai's ROE for 2023 and 2024 was 34.19% and 36.02%, respectively, an increase of 2 percentage points. Considering that Moutai holds a large amount of cash that is not effectively utilized, the ROE excluding cash in 2024 may reach around 50%. This means that Moutai could potentially recover its investment costs within two years.

2. Gross Margin#

Gross Margin = (Operating Revenue - Operating Costs) / Operating Revenue, directly reflecting the profit space of a product. For example, if a product sells for 100 yuan and costs 40 yuan, the gross margin is 60%. Buffett believes that the gross margin should be above 40%, as a high gross margin indicates that the product has unique advantages, a wide moat, and strong risk resistance.

In the Chinese liquor industry, gross margins are generally high. Taking 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 Profit Margin#

Net Profit Margin = Net Profit / Operating Revenue, representing the actual profit after deducting all costs and expenses. If a company has a high gross margin but excessive management or sales expenses, the net profit may not be ideal. Buffett requires a net profit margin greater than 5%.

For Kweichow Moutai in 2023 and 2024, the net profit margins were 49.5% and 51.2%, respectively, an increase of 1.7 percentage points year-on-year. This indicates that Moutai may have reduced management or sales expenses.

These are the three core criteria Buffett uses for stock selection, but company analysis also includes other indicators such as price-to-earnings ratio and differentiation.

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