What income statement is to Warren Buffett
Earlier, I had written about me reading on this book – Warren Buffett and the Interpretation of Financial Statements. I had also said that I will share as I read so that we will have some notion as to what Warren Buffet sees in financial statements.
First of all, it is worth noting that Warren believes in value investing and he also believes that if a company is trading below its worth, then the downside risk is much smaller compared to what it is if it was trading above its worth.
One of the ways that Warren uses to ascertain this is through financial statements. And the key thing to see in it is the income statement. A typical statement will look like the above, which I have borrowed from the same book.
An income statement tells us how much the company is earning in a given period. Apart from that, it is also used to determine the following – company’s margins, its return on equity and the direction of its earnings. Of course, as with all sets of numbers, seeing one set of numbers does not provide any meaning, it has to be seen in a series of performances, which will determine the consistency of its earnings.
As you can see, the income statement is divided into 3 main parts – the revenue of the business, the expenses and the profit/ loss part.
Part of Warren’s success is to find long term durable companies which is usually as a result of some competitive edge it has. It is important to note that making a profit or not is not what Warren is looking for, rather it is how the money is made and what the money is then used for. Money invested in R&D to maintain its competitive edge is part of what makes a company durable.
To be honest, whenever I receive the annual report of the stocks I buy, I just chuck it at a corner, loudly proclaiming it to be useless. Now, I will pay more attention to it and practise some of what I read here.
Next, I will explore components of the income statment and will share with you too. Stay tuned!
