Warren Buffett and the Interpretation of Financial Statements: The Search for the Company with a Durable Competitive Advantage

by Mary Buffett

Companies with gross profit margins of 40% or better tend to be companies with some sort of durable competitive advantage.

As an example, Coca-Cola’s depreciation expense consistently runs about 6% of its gross profits, and Wrigley’s, another durable competitive advantage holder, also runs around 7%.

As a rule, Warren’s favorite durable competitive advantage holders in the consumer products category all have interest payouts of less than 15% of operating income.

The equation is: Debt to Shareholders’ Equity Ratio = Total Liabilities ÷ Shareholders’ Equity.

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.

The first is when you need money to make an investment in an even better company at a better price, which occasionally happens.

The second is when the company looks like it is going to lose its durable competitive advantage.