Thread by @BrianFeroldi

How to analyze an Income Statement, FAST.

Warren Buffett’s 8 Income Statement 'Rules of Thumb':

1: Gross Margin

🧮 Equation: Gross Profit / Revenue

👍 Rule of Thumb: 40% or higher

🤔 Buffett's Logic: A consistently high gross margin signals that the company isn’t competing exclusively on price.

2: SG&A Margin

🧮 Equation: SG&A Expense / Gross Profit

👍 Rule of Thumb: 30% or lower

🤔 Buffett's Logic: Wide-moat companies don’t need to spend a lot on overhead to operate & convince consumers to buy.

3: R&D Margin

🧮 Equation: R&D Expense / Gross Profit

👍 Rule of Thumb: 30% or lower

🤔 Buffett's Logic: R&D expenses don't always create value for shareholders. Buffett doesn't want to own companies that need to invent the next great product to do well.

4: Depreciation Margin

🧮 Equation: Depreciation / Gross Profit

👍 Rule of Thumb: 10% or lower

🤔 Buffett's Logic: Buffett doesn't like businesses that constantly need to invest in depreciating assets to maintain their competitive advantage.

5: Interest Expense Margin

🧮 Equation: Interest Expense / Operating Income

👍 Rule of Thumb: 15% or lower

🤔 Buffett's Logic: Great businesses have such incredible economics that they don’t need debt to finance themselves.

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6: Income Tax Expenses

🧮 Equation: Taxes Paid / Pre-Tax Income

👍 Rule of Thumb: Current Corporate Tax Rate

🤔 Buffett's Logic: Great businesses make so much money that they are consistently forced to pay their full share of taxes.

7: Net Margin (Profit Margin)

🧮 Equation: Net Income / Sales

👍 Rule of Thumb: 20% or higher

🤔 Buffett's Logic: Companies that consistently convert 20% of their revenue into net income are more likely to have a durable competitive advantage.

8: Earnings Per Share Growth

🧮 Equation: Year 2 EPS / Year 1 EPS

👍 Rule of Thumb: Positive & Growing

🤔 Buffett's Logic: Great companies consistently generate profits and increase them every year regardless of the operating environment.

Caveats:

1: These “rules of thumb” are only useful when a company is mature and fully optimized for profits (stage 4/5).

2: CONSISTENCY is key.

3: There are PLENTY of exceptions & nuances to these rules.

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