More on this book
Community
Kindle Notes & Highlights
by
Mary Buffett
Read between
August 21 - August 30, 2017
The Tao of Warren Buffett, Buffettology, The Buffettology Workbook, and The New Buffettology,
Read these books
As a very general rule (and there are exceptions): Companies with gross profit margins of 40% or better tend to be companies with some sort of durable competitive advantage.
One of these is high research costs, another is high selling and administrative costs, and a third is high interest costs on debt. Any one of these three costs can destroy the long-term economics of the business. These are called operating expenses, and they are the thorn in the side of every business.
Here then is Warren’s rule: Companies that have to spend heavily on R&D have an inherent flaw in their competitive advantage that will always put their long-term economics at risk,
What Warren has discovered is that companies that have a durable competitive advantage tend to have lower depreciation costs as a percentage of gross profit than companies that have to suffer the woes of intense competition.
What Warren has figured out is that companies with a durable competitive advantage often carry little or no interest expense.
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 rule here is real simple: In any given industry the company with the lowest ratio of interest payments to operating income is usually the company most likely to have the competitive advantage.
Warren has learned over the years that companies that are busy misleading the IRS are usually hard at work misleading their shareholders as well.
Though most financial analysis focuses on a company’s per-share earnings, Warren looks at the business’s net earnings to see what is actually going on.
A simple rule (and there are exceptions) is that if a company is showing a net earnings history of more than 20% on total revenues, there is a real good chance that it is benefiting from some kind of long-term competitive advantage.
What Warren looks for is a per-share earning picture over a ten-year period that shows consistency and an upward trend.
Assets minus Liabilities = Net Worth or Shareholders’ Equity
So here is the rule: If we see a lot of cash and marketable securities and little or no debt, chances are very good that the business will sail on through the troubled times. But if the company is hurting for cash and is sitting on a mountain of debt, it probably is a sinking ship that not even the most skilled manager can save.
Lest we forget, cash is king when troubled times hit, so if we have it when our competitors don’t, we get to rule.
When trying to identify a manufacturing company with a durable competitive advantage, look for an inventory and net earnings that are on a corresponding rise. This indicates that the company is finding profitable ways to increase sales, and that increase in sales has called for an increase in inventory, so the company can fulfill orders on time.
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.
current ratio, which is derived by dividing current assets by current liabilities;
A current ratio of over one is considered good, and anything below one bad. If it is below one, it is believed that the company may have a hard time meeting its short-term obligations to its creditors.
As Warren says, producing a consistent product that doesn’t have to change equates to consistent profits.
An example of Other Long-Term Assets would be prepaid expenses and tax recoveries that are due to be received in the coming years.
While many analysts argue that the higher the return on assets the better, Warren has discovered that really high returns on assets may indicate vulnerability in the durability of the company’s competitive advantage. Raising $43 billion to take on Coca-Cola is an impossible task—it’s not going to happen. But raising $1.7 billion to take on Moody’s is within the realm of possibility. While Moody’s underlying economics is far superior to Coca-Cola’s, the durability of Moody’s competitive advantage is far weaker because of the lower cost of entry into its business. The lesson here is that
...more
When it comes to investing in financial institutions Warren has always shied away from companies that are bigger borrowers of short-term money than of long-term money.
By dividing Total Current Assets by Total Current Liabilities, one can determine the liquidity of the company—the higher the current ratio, the more liquid the company is, and the greater its ability to pay current liabilities when they come due.
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.
Debt to Shareholders’ Equity Ratio = Total Liabilities ÷ Shareholders’ Equity.
The odd thing about preferred stock is that companies that have a durable competitive advantage tend not to have any.
the rate of growth of a company’s retained earnings is a good indicator whether or not it is benefiting from having a durable competitive advantage.
The theory is simple: the more earnings that a company retains, the faster it grows its retained earnings pool, which, in turn will increase the growth rate for future earnings.
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.
Calculation: Net Earnings divided by Shareholders’ Equity equals Return on Shareholders’ Equity.
High returns on shareholders’ equity means “come play.” Low returns on shareholders’ equity mean “stay away.”
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.
