Seppo Sinisaari

Warren Buffett’s Financial Statement Rules of Thumb: INCOME STATEMENT RULES OF THUMB: 1: Gross Margin →Equation: Gross Profit / Revenue →Rule: 40% or higher →Logic: Signals the company isn’t competing on price. 2: SG&A Margin →Equation: SG&A Expense / Gross Profit →Rule: 30% or lower →Logic: Wide-moat companies don’t need to spend much on overhead to operate. 3: R&D Margin →Equation: R&D Expense / Gross Profit →Rule: 30% or lower →Logic: R&D expenses don't always create value for shareholders. 4: Depreciation Margin →Equation: Depreciation / Gross Profit →Rule: 10% or lower →Logic: Great businesses don't need a lot of depreciating assets to maintain their competitive advantage. 5: Interest Expense Margin → Equation: Interest Expense / Operating Income → Rule: 15% or lower →Logic: Great businesses don’t need debt to finance themselves. 6: Income Tax Expenses → Equation: Taxes Paid / Pre-Tax Income → Rule: Current Corporate Tax Rate →Logic: Great businesses are so profitable that they are forced to pay their full tax load. 7: Net Margin (Profit Margin) → Equation: Net Income / Sales → Rule: 20% or higher → Logic: Great companies convert 20% or more of their revenue into net income. 8: Earnings Per Share Growth → Equation: Year 2 EPS / Year 1 EPS → Rule: Positive & Growing → Logic: Great companies increase profits every year. ⚖ BALANCE SHEET RULES OF THUMB: 9: Cash & Debt → Equation: Cash > Debt → Rule: More cash than debt → Buffett's Logic: Great companies don't need debt to fund themselves. 10: Cash & Debt → Equation: Cash > Debt →Rule: More cash than debt →Logic: Great companies generate lots of cash without needing much debt. 11: Adjusted Debt to Equity →Equation: Total Liabilities / Shareholder Equity + Treasury Stock →Rule: < 0.80 →Logic: Great companies finance themselves with equity. 12: Preferred Stock → Rule: None → Logic: Great companies don't need to fund themselves with preferred stock. 13: Retained Earnings → Equation: Year 1 / Year 2 → Rule: Consistent growth →Logic: Great companies grow retained earnings each year. 14: Treasury Stock Rule: Exists → Logic: Great companies repurchase their stock. 💸 CASH FLOW STATEMENT: 15: Capex Margin →Equation: Capex / Net Income → Rule: <25% → Logic: Great companies don't need much equipment to generate profits. Caveats: 1️⃣ There are plenty of exceptions to these rules. 2️⃣ CONSISTENCY IS KEY! Want to go deeper into analyzing financial statements? Join me tomorrow (Thursday, Oct 12th) for a FREE webinar. Topic: How to analyze unprofitable business. RSVP here: lu.ma/unprofitable Follow me @BrianFeroldi for more content like this. What "rule of thumb" do you like best?