How Does Buffett Quickly Analyze a Stock?#
In the stock selection process, Buffett typically filters companies by analyzing financial statements. In the book "Working with a Tap Dance," a reporter asked Buffett, "Where do your ideas come from?" He replied, "Just from reading; my daily work is reading." By reading annual reports and analyzing specific financial metrics, he conducts preliminary screenings.
1. Return on Equity (ROE)#
This metric measures 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. As a comprehensive indicator, it reflects the overall operational status of the enterprise. Buffett believes that the return on equity should be above 15%. (The following analysis is based on the financial reports of Kweichow Moutai for 2023 and 2024).
For example, Kweichow Moutai's return on equity for 2023 and 2024 is 34.19% and 36.02%, respectively, an increase of 2 percentage points. However, considering that Moutai has a large amount of idle cash that is not effectively utilized, the return on equity excluding cash in 2024 may approach 50%. This means Moutai could recover its investment costs within two years.
2. Gross Margin#
Gross Margin = (Operating Revenue - Operating Costs) / Operating Revenue, this metric directly reflects 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%. 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 Moutai as an example, the gross margins for 2023 and 2024 are 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, represents the actual profit received, i.e., the earnings 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 profit margin. Buffett believes that the net profit margin should be greater than 5%.
For Kweichow Moutai in 2023 and 2024, the net profit margins are 49.5% and 51.2%, respectively, a year-on-year increase of 1.7 percentage points. This indicates that Moutai may have reduced management or sales expenses.
The above are three key criteria for Buffett's stock selection, but company analysis goes beyond this, also including factors such as price-to-earnings ratio and differentiation.
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