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

by Mary Buffett

In Warren’s world the price you pay directly affects the return on your investment. Since he is looking at a company with a durable competitive advantage as being a kind of equity bond, the higher the price he pays, the lower his initial rate of return and the lower the rate of return on the company’s earnings in ten years. Let’s look at an example: In the late 1980s, Warren started buying Coca-Cola for an average price of $6.50 a share against earnings of a $.46 a share, which in Warren’s world equates to an initial rate of return of 7%. By 2007 Coca-Cola was earning $2.57 a share. This means that Warren can argue that his Coca-Cola equity bond was now paying him $2.57 a share on his original investment of $6.50, which equates to a return of 39.9%. But if he had paid $21 a share for his Coca-Cola stock back in the late 1980s, his initial rate of return would have been 2.2%. By 2007 this would have grown only to 12% ($2.57 ÷ $21 = 12%), which is definitely not as attractive a number as 39.9%.