Financial Statement Rules of Thumb:
💰 INCOME STATEMENT:
1: Gross Margin
🧮 Equation: Gross Profit / Revenue
👍 Rule: 40% or higher
🤔 Buffett's Logic: Signals the company isn’t competing on price.
2: SG&A Margin
🧮 Equation: SG&A Expense / Gross Profit
👍 Rule: 30% or lower
🤔 Buffett's Logic: Wide-moat companies don’t need to spend a lot on overhead to operate.
3: R&D Margin
🧮 Equation: R&D Expense / Gross Profit
👍 Rule: 30% or lower
🤔 Buffett's Logic: R&D expenses don't always create value for shareholders.
4: Depreciation Margin
🧮 Equation: Depreciation / Gross Profit
👍 Rule: 10% or lower
🤔 Buffett's Logic: Buffett doesn't like businesses that need to invest in depreciating assets to maintain their competitive advantage.
5: Interest Expense Margin
🧮 Equation: Interest Expense / Operating Income
👍 Rule: 15% or lower
🤔 Buffett's Logic: Great businesses don’t need debt to finance themselves.
6: Income Tax Expenses
🧮 Equation: Taxes Paid / Pre-Tax Income
👍 Rule: Current Corporate Tax Rate
🤔 Buffett's Logic: Great businesses are so profitable that they are forced to pay their full tax load.
7: Net Margin (Profit Margin)
🧮 Equation: Net Income / Sales
👍 Rule: 20% or higher
🤔 Buffett's Logic: Great companies convert 20% or more of their revenue into net income.
8: Earnings Per Share Growth
🧮 Equation: Year 2 EPS / Year 1 EPS
👍 Rule: Positive & Growing
🤔 Buffett's Logic: Great companies increase profits every year.
⚖ BALANCE SHEET:
9: Cash & Debt
🧮 Equation: Cash > Debt
👍 Rule: More cash than debt
🤔 Buffett's Logic: Great companies don't need debt to fund themselves.
10: Cash & Debt
🧮 Equation: Cash > Debt
👍 Rule: More cash than debt
🤔 Buffett's Logic: Great companies generate lots of cash without needing much debt.
11: Adjusted Debt to Equity
🧮 Equation: Total Liabilities / Shareholder Equity + Treasury Stock
👍 Rule : < 0.80
🤔 Buffett's Logic: Great companies finance themselves with equity.
12: Preferred Stock
👍 Rule: None
🤔 Buffett's Logic: Great companies don't need to fund themselves with preferred stock.
13: Retained Earnings
🧮 Equation: Year 1 / Year 2
👍 Rule: Consistent growth
🤔 Buffett's Logic: Great companies grow retained earnings each year.
14: Treasury Stock
👍 Rule: Exists
🤔 Buffett's Logic: Great companies repurchase their stock.
💸 CASH FLOW STATEMENT:
15: Capex Margin
🧮 Equation: Capex / Net Income
👍 Rule: <25%
🤔 Buffett's Logic: Great companies don't need much equipment to generate profits.
Caveats:
1️⃣ There are plenty of exceptions to these rules.
2️⃣ CONSISTENCY IS KEY!
________
🤔That's it for today. What is your favorite "rules of thumb"? Join the discussion in the comments 👇
image and caption are taken from Linkedin
credit - nafees ul hassan
(comment for removal )
