How does Buffett quickly analyze a stock?

Warren Buffett often selects stocks by analyzing financial statements. In the book "Jumping in Tap Dance to Work," a reporter asked Buffett: Where do your ideas come from? He replied: Just by reading; my daily job is reading.

Through reading the annual report, analyze specific financial indicators for preliminary screening.

1. Return on Equity
This indicator reflects the company's ability to utilize capital, commonly represented by the formula ROE = Net Profit / Average Net Assets. It can also be broken down into three elements using the DuPont analysis: ROE = Net Profit Margin * Asset Turnover * Financial Leverage. As an indicator, it can generally reflect the operational situation of the enterprise. Buffett believes that the return on equity should be above 15%. (The following standard analysis references the financial reports of Kweichow Moutai for 2023 and 2024.)

For example, the return on equity for Moutai in 2023 and 2024 is 34.19% and 36.02% respectively, indicating an increase of 2 percentage points in the return on equity. However, considering that Moutai has a large amount of cash sitting idle on its balance sheet, the return on equity excluding cash in 2024 may reach around 50%. In other words, Moutai will recoup its invested costs within two years.

2. Gross Margin
Gross margin = (Operating income - Operating cost) / Operating income. The gross margin of a product directly reflects the profit space of the product. For example, if a product costs 100 yuan and the cost is 40 yuan, the gross margin would be 60%. Buffett believes that the gross margin should be above 40%. A high gross margin indicates that the product has unique advantages, a relatively wide moat, and stronger risk resistance.

In the Chinese liquor industry, the gross profit margin is relatively high. Taking Moutai as an example, the gross profit margins for 2023 and 2024 are 92.11% and 92.01%, respectively, a year-on-year decrease of 0.1 percentage points.

3. Net profit margin
Net profit margin = net profit / operating income, which is essentially the actual profit received, and it is the profit after deducting all costs and expenses. If a company has a high gross profit margin but high management and selling expenses, it will erode profits and lead to unsatisfactory net profit. Buffett believes that the net profit margin should be >5%.

Taking Moutai in 2023 and 2024 as examples, the net profit margins are 49.5% and 51.2%, respectively, an increase of 1.7 percentage points year-on-year. This indicates that Moutai may have reduced management or selling expenses.

The above are Buffett's three criteria for stock selection, but analyzing a company goes far beyond these three standards, including price-to-earnings ratio, differentiation, and more.