Series 2: How did Warren Buffett find a durable competitive company?

 

After seeing the investment results from Warren Buffett in the previous article here , do you want to know how Warren Buffett was able to find his flagship stock?

Of course, Warren Buffett must first analyze the company's financial statements. Because the company's financial statements are a mining location for Warren Buffett, and that's where he found gold (a company with a durable competitive advantage ) that made him as rich as he is today. There are three important parts in the financial statements, namely the income statement, balance sheet, and cash flow.

Due to the large number of sub-sections of the three reports, we will discuss several series one by one in the future. For series 2, we start by discussing the income statement. To find a company with a durable competitive advantage , Warren Buffet always starts by looking at the income statement.

The income statement or income statement is a report that can tell us how much money a company can generate. In this report, we can find out how much margin, return equity and most importantly the consistency of the profit generated.

“You better read the billions of companies' annual reports and their financial reports.”

Warren Buffett

Then, what does Warren Buffett pay attention to when reading a company's income statement? Following are some of the criteria for companies that have a durable competitive advantage:

Gross Profit Margin (GPM)

GPM must be above 40% and be able to maintain GPM consistency in the long term. With a high GPM, the company is able to avoid price competition because it is able to determine its own price.

Selling, General, and Administrative Expenses (SGA)

The ratio of SGA to gross profit is in the range of 30% -80%. The lower the SGA expenditure, the better. Because a high ratio of SGA to gross profit will be very risky for the company in the long run.

Research and Development Expenses (R&D)

Warrant Buffett strongly avoids companies that spend heavily on R&D. Why? Companies that spend a lot of money on R&D are companies that are at risk for long-term holding, because it reflects that their products can be easily replaced in the future.

Interest Expense

Interest expense is something that Warren Buffett avoids, because interest expense is a reflection of a company's total debt. The higher the interest expense, the higher the total debt owned by the company. The ratio of interest expenses to operating income is less than 15%.

Net Profit Margin (NPM)

Companies with durable competitive advantage have consistent NPM above 20% or net earnings that always grow in the long term. The high NPM will increase the profits that will be obtained by investors which can be seen from the level of ROE and dividends distributed.

Earning per Share (EPS)

The higher the EPS value, the higher the price of a stock. A company with consistent EPS and one that has always grown over the past 10 years is one of the characteristics of a company that has a durable competitive advantage.

Is the income statement enough to determine which company has a durable competitive advantage ? Of course not. For this reason, we will discuss how Warren Buffett analyzes companies from their balance sheet reports. Stay tuned for the next 3 series!!!

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