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Subject:  Buffett and Financial Statements Notes Date:  12/24/2008  1:30 PM
Author:  Jognils Number:  2580 of 2683

I just finished "Warren Buffett and the Interpretation of Financial Statements" (thanks for the recommendation, Aaron!) and I wanted to share some notes I made while I was reading. I'll keep the commentary minimal and basically paraphrase what the authors, Mary Buffett and David Clark, say about how Warren looks at financial statements. (By the way, Mary is Buffett's daughter-in-law and David is an old student and self-proclaimed Buffettologist.)

The main idea of the book is to use a company's financials to determine whether it has what Warren calls a "durable competitive advantage." Companies that have a durable competitive advantage benefit from "monopoly-like economics, allowing them either to charge more or to sell more of their products. In the process, they [make] a ton more money than their competitors... if a company's competitive advantage could be maintained for a long-period of time - if it was "durable" - then the underlying value of the business would increase year after year." (page 8)

Buffett's strategy is to find companies with a durable competitive advantage (they use the term a lot, so I'll refer to it as a DCA) and to hold them for decades because the business itself is constantly increasing in value, and sooner or later the stock market realizes that and the stock price adjusts accordingly. The book is organized by the parts of each financial statement, so I'll start where they started, with the income statement. These are some of the more prominent numbers on the income statement that can help determine the presence or absence of a DCA.

- Gross margin: If a company has consistently higher gross margins than its competitors (the book says 40% or higher as a general rule), it means the company doesn't have to worry abo