Income Statement clues

... cont'd from yesterday...

Continued discussion about Warren Buffett and the Interpretation of Financial Statements: The Search for the Company with a Durable Competitive Advantage

Step One: Start with the Statement of Income and Expenses.

1. Profit Income Ratio, namely (Gross Revenue – Cost of Goods Sold)/Gross Revenue. This ratio must year after year be over 40%.

2. Selling, General & Administration Expense (“SGA”). The lower the better, but best of all is a year after year consistent ratio of SGA/Gross Income.

3. Research & Development Expense. This needs to be zero or almost zero to qualify as an ECDCA.

4. Depreciation Expense. This needs to be less than 10% to qualify as an ECDCA.

5. Interest Expense. This needs to be zero or almost zero to qualify as an ECDCA. The subject company’s ratio of Interest/Gross Income should be the lowest in the industry to qualify as an ECDCA.

6. Gain or Loss from Sale of Assets. This number has to be removed from calculating the Net Income for the purposes of deciding if a company qualifies as an ECDCA.

7. Income Taxes Paid. The amount reported is used as an idication of whether the subject company has crooked accountants and therefore disqualified as an ECDCA. If the amount reported as Income Taxes Paid is far off from 35% of Before-Tax Income, then the company is disqualified as an ECDCA. Before-Tax Income is Gross Revenue minus all Expenses (except for Income Tax).

8. Net Earnings. Obvious ECDCA’s have Ratio of Net Earnings/Revenue over 20%. Obvious non-ECDCA have that ratio under 10%. In between 10% to 20% is an area where the Net Earnings/Revenue ratio is not decisive in determining ECDCA status.

9. Earnings Per Share. ECDCA’s have a consistently rising EPS over a 10 year period instead of an erratic up and down movement over a 10 year period.

...cont'd tomorrow...

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