In the last part, we talked about what Warren Buffett looks for in an income statement in order to determine whether a company has long-term competitive advantage.
Here are what Warren Buffett looks for when interpreting a balance sheet:
- Positive if the company hold a lot of cash, short-term investments and has little or no debt
- Positive competitive advantage when a company has low percentage of net receivables to gross sales
- Positive when the current ratio of a company is greater than 1; bad when current ratio is less than 1
- Increase in goodwill over a number of years means company has been buying out other businesses. It is even better if the company is buying other companies that have durable advantage.
- Lower the return on asset ratio the better the competitve advantage
- A debt to shareholders’ equity ratio lower than 0.80 mean the company has positive long-term competitve advantage
- Companies that have durable competitive advantage tend not to have any preferred stocks
- The more earnings the a company retains, the faster it grows its retained earnings pool, which in turn will increase 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 has a durable competitive advantage
- Companies that benefit from a durable or long-term competitive advantage show higher-than-average return on shareholders’ equity
Lastly, this is what any investor should look for in a cash flow statement:
- Company historically using 50% or less of its annual net earnings for capital expeditures tend to have durable competitive advantage
Again, I will do some analysis on the stocks I am interested in investing in. I will go over the accounting terms I have mentioned in more details at that time.
Please feel free to comment below! Catch you on the flip side!