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," when asked about the source of his thoughts, Buffett replied, "My daily work is reading." He conducts preliminary screening by reading annual reports and analyzing specific financial indicators.
1. Return on Equity (ROE)#
Return on equity measures a company's ability to utilize capital, commonly calculated using the formula ROE = Net Profit / Average Equity. Through the DuPont analysis, ROE can be broken down into three components: net profit margin, asset turnover, and financial leverage. This indicator can reflect the overall operational status of a company. Buffett suggests that the return on equity should be above 15% (the following analysis is based on the 2023 and 2024 financial reports of Kweichow Moutai).
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 fully utilized, the return on equity after deducting cash in 2024 may approach 50%. This means that Moutai can recover its investment costs within two years.
2. Gross Margin#
Gross margin = (Operating Income - Operating Costs) / Operating Income, which 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 requires a gross margin 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 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 Income, indicating the actual profit after deducting all costs and expenses. Even if the gross margin is high, excessive management or sales expenses can erode profits, resulting in a poor net profit margin. Buffett suggests 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, which may indicate a decrease in management or sales expenses.
These are the three key criteria Buffett uses for stock selection, but company analysis goes beyond this, including factors like price-to-earnings ratio and differentiation.
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