How Does Buffett Swiftly Evaluate a Stock?

When choosing stocks, Warren Buffett frequently assesses companies by reviewing their financial documents. In his publication Tap Dancing to Work, a reporter once inquired: “Where do your ideas originate?” He responded: “Simply through reading. My daily role is primarily to read consistently.”

By perusing annual reports and scrutinizing crucial financial metrics, Buffett performs an initial evaluation of firms.

1. Return on Equity (ROE)

This measure indicates a company's proficiency in capital utilization. A standard equation is ROE = Net Profit / Average Shareholder’s Equity. Based on DuPont Analysis, ROE can be decomposed into: ROE = Net Profit Margin × Asset Turnover × Financial Leverage. As a standalone figure, ROE offers a comprehensive view of corporate performance. Buffett contends ROE should surpass 15%. (The subsequent analysis employs Kweichow Moutai’s 2023 and 2024 financial data.)

Illustration: Moutai’s ROE for 2023 and 2024 stood at 34.19% and 36.02%, respectively, rising by 2 percentage points. Given Moutai’s substantial idle cash holdings, its adjusted ROE (excluding cash) might approach roughly 50% in 2024. In essence, Moutai could recoup its investment within two years.

2. Gross Profit Margin

Gross Profit Margin = (Operating Revenue – Operating Costs) / Operating Revenue. This ratio directly reveals a product's profit potential. For instance, if an item sells for ¥100 with a ¥40 production cost, the gross margin is 60%. Buffett seeks margins exceeding 40%. A high gross margin signifies strong product uniqueness, a broad economic barrier, and robust risk resilience.

In China’s liquor sector, gross margins are notably elevated. For example, Moutai’s gross margin in 2023 and 2024 was 92.11% and 92.01%, respectively—a minor drop of 0.1 percentage point year-over-year.

3. Net Profit Margin

Net Profit Margin = Net Profit / Operating Revenue. This displays actual profit after all deductions. A firm might boast high gross margins, but excessive management or marketing expenses can diminish net profits. Buffett favors companies with a net profit margin above 5%.

For Moutai, net profit margins in 2023 and 2024 were 49.5% and 51.2%, respectively—an uptick of 1.7 percentage points year-over-year. This implies potential reductions in management or sales costs.

These represent three of Buffett’s pivotal stock-selection criteria. However, company analysis extends beyond these, incorporating elements like P/E ratio and competitive distinctiveness.

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