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Kindle Notes & Highlights
by
Mary Buffett
Read between
March 20 - March 22, 2021
Current Assets is made up of “cash and cash equivalents,” “short-term investments,” “net receivables,” “inventory,” and a general slush fund called “other assets.” These are called current assets because they are cash, or they can be or will be converted into cash in a very short period of time (usually within a year).
All other assets are those that aren’t current, which means that they will not or cannot be converted into cash in the year ahead;
Current assets are also referred to as the “working assets” of the business because they are in the cycle of cash going to buy inventory; Inventory is then sold to vendors and becomes Accounts Receivable.
Warren one of two things—that a company has a competitive advantage that is generating tons of cash, which is a good thing, or that it has just sold a business or a ton of bonds, which may not be a good thing.
receivables. If a company is consistently showing a lower percentage of Net Receivables to Gross Sales than its competitors, it usually has some kind of competitive advantage working in its favor that the others don’t have.
Other current assets are non-cash assets that are due within the year but are not as yet in the company’s hands.
deferred income tax recoveries, which are due within the year, but aren’t cash in hand just yet.
Total Current Assets is a number that has long played an important role in financial analysis.
In short, there are many companies with a durable competitive advantage that have current ratios less than one. Such companies create an anomaly that renders the current ratio almost useless in helping us identify whether or not a company has a durable competitive advantage.
They are carried at their original cost, less accumulated depreciation.
What is interesting about the long-term investment account is that this asset class is carried on the books at their cost or market price, whichever is lower. But it cannot be marked to a price above cost even if the investments have appreciated in value. This means that a company can have a very valuable asset that it is carrying on its books at a valuation considerably below its market price.
An example of Other Long-Term Assets would be pre-paid expenses and tax recoveries that are due to be received in the coming years. There is little that Other Long-Term Assets can tell us about whether or not the company in question has a durable competitive advantage. So let’s move on.
Current liabilities are the debts and obligations that the company owes that are coming due within the fiscal year.
Accounts payable is money owed to suppliers that have provided goods and services to the company on credit.
Accrued expenses are liabilities that the company has incurred, but has yet to be invoiced for.
These expenses include sales tax payable, wages payable, and accrued rent payable.
Accounts Payable, Accrued Expenses, and Other Debts can tell us a lot about the current situation of a business, but as stand-alone entries they tell us little about the long-term economic nature of the business and whether or not it has a durable competitive advantage.
Short-term debt is money that is owed by the corporation and due within the year. This includes commercial paper and short-term bank loans.
This is what happened to Bear Stearns: They borrowed short-term and bought mortgage-backed securities, using the mortgage-backed securities as collateral for the short-term loans.
The smartest and safest way to make money in banking is to borrow it long-term and lend it long-term.
But an aggressive bank, like Bank of America N.A., has $2.09 of short-term debt for every dollar of long-term debt. And while being aggressive can mean making lots of money over the short-term, it has often led to financial disasters over the long-term. And one never gets rich being on the downside of a financial disaster.
Where it can create problems is when some companies lump it in with short-term debt on the balance sheet, which creates the illusion that the company has more short-term debt than it really does.
By dividing Total Current Assets by Total Current Liabilities,
the higher the current ratio, the more liquid the company is, and the greater its ability to pay current liabilities when they come due.
Long-term debt means debt that matures any time out past a year. On the balance sheet it comes under the heading of long-term liabilities.
Warren’s historic purchases indicate that on any given year the company should have sufficient yearly net earnings to pay off all of its long-term debt within a three- or four-year earnings period.
The bottom line here is that companies that have enough earning power to pay off their long-term debt in under three or four years are good candidates in our search for the excellent business with a long-term competitive advantage.
targets of leveraged buyouts.
In cases like these the company’s bonds are often the better bet, in that the company’s earning power will be focused on paying off the debt and not growing the company.
Little or No Long-Term Debt Often Means a Good Long-Term Bet.
Deferred Income Tax is tax that is due but hasn’t been paid.
The Minority Interest entry on a balance sheet is far more interesting. When the company acquires the stock of another, it books the price it paid for the stock as an asset under “long-term investments.” But when it acquires more than 80% of the stock of a company, it can shift the acquired company’s entire balance sheet onto its balance sheet.
“Other Liabilities” is a catchall category into which businesses pool their miscellaneous debt. It includes such liabilities as judgments against the company, non-current benefits, interest on tax liabilities, unpaid fines, and derivative instruments.
Total liabilities is the sum of all the liabilities of the company.
The equation is: Debt to Shareholders’ Equity Ratio = Total Liabilities ÷ Shareholders’ Equity.
On average, the big American money center banks have $10 in liabilities for every dollar of shareholders’ equity they keep on their books. This is what Warren means when he says that banks are highly leveraged operations.
The simple rule here is that, unless we are looking at a financial institution, any time we see an adjusted debt to shareholders’ equity ratio below .80 (the lower the better), there is a good chance that the company in question has
shareholders’ equity or book value of the business.
There is a second class of equity, called preferred stock. Preferred shareholders don’t have voting rights, but they do have a right to a fixed or adjustable dividend that must be paid before the common stock owners receive a dividend.
Retained Earnings is an accumulated number, which means that each year’s new retained earnings are added to the total of accumulated retained earnings from all prior years.
Out of all the numbers on a balance sheet that can help us determine whether the company has a durable competitive advantage, this is one of the most important.
Thus one of the hallmarks of a company with a durable competitive advantage is the presence of treasury shares on the balance sheet.
Since a high return on shareholders’ equity is one sign of a durable competitive advantage, it is good to know if the high returns on equity are being generated by financial engineering or exceptional business economics or because of a combination of the two. To see which is which, convert the negative value of the treasury shares into a positive number and add it to the shareholders’ equity instead of subtracting it. Then divide the company’s net earnings by the new total shareholders’ equity.
Let us leave this chapter with a simple rule: The presence of treasury shares on the balance sheet, and a history of buying back shares, are good indicators that the company in question has a durable competitive advantage working in its favor.
The third, and most important to us, is the accumulation of retained earnings.
Calculation: Net Earnings divided by Shareholders’ Equity equals Return on Shareholders’ Equity.
So here is the rule: High returns on shareholders’ equity means “come play.” Low returns on shareholders’ equity mean “stay away.”
a Cash Method sales are only booked when the cash comes in.
Buying a new truck for your company is a capital expenditure, the value of the truck will be expensed through depreciation over its life—let’s say six years. But the gasoline used in the truck is a current expense, with the full price deducted from income during the current year.
Warren has discovered that if a company is historically using 50% or less of its annual net earnings for capital expenditures, it is a good place to look for a durable competitive advantage. If it is consistently using less than 25% of its net earnings for capital expenditures, that scenario occurs more than likely because the company has a durable competitive advantage working in its favor.
