Summary of the book Warren Buffett and the interpretation of financial statements

“You have to understand accounting and you have to understand the nuances of accounting. It’s the language of business and it’s an imperfect language, but unless you are willing to put in the effort to learn accounting — how to read and interpret financial statements — you really shouldn’t select stocks yourself. “– Warren Buffett.

Warren Buffett, born in Omaha, Nebraska is one of the most successful investors in the world with a net worth of over $113 billion as of June 2022. He is the fifth richest person in the world.

He started buying stocks at 11, filed for tax at 13, and formulated his investment philosophy around Benjamin Graham, an American economist, and investor while at Columbia University. Implementing and sticking to his philosophy centred around value investing, he became the chairman and largest shareholder of Berkshire Hathaway in 1965.

When Warren Buffett became the largest shareholder of Berkshire Hathaway it was a large but struggling textile company. However, over the years, he has been able to turn it around into one of the largest holding companies in the world. He did this by investing in companies that have a “durable competitive advantage” and a long history of paying dividends. He reinvested the dividends he got from these companies to buy more durable companies without paying dividends to Berkshire Hathaway investors.

For Warren Buffett, identifying super companies with a durable competitive advantage is key. One of the ways he does this is by looking at their business model. They often come in 3 types.

1. They sell a unique product, e.g., Coca-Cola; it has been selling the same product for over 130 years,

2. They sell a unique service, e.g., Moody’s Corp., Wells Fargo and co,

3. They are the low-cost buyer or sellers of a product the public consistently needs e.g., Walmart

For Warren Buffett, this consistency in product or service creates consistent profits as the company doesn’t have to invest in manufacturing plants, research and development or changing its product to keep up with the competition. This means the company can save a lot of cash and avoid carrying debt or paying interest. With the excess cash available, the company can expand its operation, buy back its stocks, and drive-up earnings and the price of the company’s stocks. This is what Warren Buffett looks out for!

This brings us to the next thing Warren Buffet uses to identify companies with a durable competitive advantage, the financial statements. The best and easiest way to find out if a company has been performing consistently is by checking and analysing its financial statement for a period of 5–10 years and finding answers to the following: does the company consistently have a high gross margin, does it consistently carry little to no debt? does it spend little or nothing on research and development? does it consistently report growing net earnings? All these along with the relevant financial ratios shows Warren Buffett the durability of the company’s competitive advantage.

Warren Buffett’s strategy helps him identify businesses with strong economics performing well consistently. it is these businesses that Warren Buffett invests in over a long period of time thus allowing his initial investments return to multiply in folds.

It is however important to note that the lower the price you buy shares of a company with durable competitive advantage the higher your return over the long term.

In Buffett’s standard, you never sell shares of a great company if it maintains its durable competitive advantage because the longer you hold the shares the better you do.

You only sell them when you need money to make an investment in an even better company at a better price, if the company is losing its competitive advantage or if the company’s shares in the stock market are selling at a price higher than the long-term economic realities of the company.

I would end this piece with a few quotes from Warren Buffett.

1. “I look for businesses in which I can predict what they’re going to look like in ten to fifteen years’ time. Take Wrigley’s chewing gum. I don’t think the internet is going to change how people chew gum”

2. “You have to read a zillion corporate annual reports and their financial statements”

3. “Some men read Playboy. I read annual reports”

The book Warren Buffett and the interpretation of financial statements was written by Mary Buffett and David Clark.