How Does Buffett Rapidly Evaluate a Stock?

When choosing stocks, Warren Buffett frequently filters companies by examining their financial reports. In his book Tap Dancing to Work, a reporter once questioned Buffett: "What sparks your investment ideas?" He answered: "Purely through reading. My daily responsibility is fundamentally centered on reading."

By studying annual reports and assessing essential financial metrics, Buffett carries out initial company screenings.

1. Return on Equity (ROE)

This measure indicates a company's proficiency in capital utilization. A standard calculation is ROE = Net Profit / Average Shareholder’s Equity. Under DuPont Analysis, ROE decomposes into: ROE = Net Profit Margin × Asset Turnover × Financial Leverage. As a standalone figure, ROE offers a comprehensive view of corporate performance. Buffett advocates for ROE to surpass 15%. (The subsequent analysis draws from 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 reserves, its adjusted ROE (excluding cash) might approach around 50% in 2024. This implies Moutai could recoup its investment in under two years.

2. Gross Profit Margin

Gross Profit Margin = (Operating Revenue – Operating Costs) / Operating Revenue. This ratio directly signals a product’s profit-generating capacity. For instance, a product selling for ¥100 with a ¥40 production cost yields a 60% gross margin. Buffett targets margins exceeding 40%. Elevated gross margins suggest strong product uniqueness, a broad economic moat, and robust risk resilience.

In China’s beverage sector, gross margins are notably high. Moutai’s gross margin in 2023 and 2024 was 92.11% and 92.01%, respectively, marking a minor 0.1 percentage point decrease year-over-year.

3. Net Profit Margin

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

For Moutai, net profit margins in 2023 and 2024 were 49.5% and 51.2%, respectively, climbing 1.7 percentage points year-over-year. This hints at potential reductions in management or sales expenses.

These represent three of Buffett’s core stock-selection principles. However, company analysis extends beyond these, encompassing elements like P/E ratios and competitive differentiation.

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How Anyone Can Analyze Stocks Like Warren Buffett