💰How to Analyze a Balance Sheet Like Warren Buffett

Hey [FIRST NAME GOES HERE],

Did you know that Bill Gates dropped out of Harvard University? He left in 1975 to pursue his vision of a software company, which eventually became Microsoft.

In today's issue:

How to analyze a balance sheet like Warren Buffett
How to buy a wonderful business
Moat, moats, and more moats
How to calculate WACC (Weigthed Average Cost of Capital)
Much more.....

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My friend Thomas Chua, one of the best writers, teachers, and investors I know. Well worth your time.

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💎NUGGETS

My Favorite Finds

Want to analyze a balance sheet like Warren Buffett, of course you do! Brian Feroldi breaks down how.

Learn how to avoid the mistake 99% of all investors make.

The Wallet Wars are coming to a theater near you. How do you prepare, what sorts of steps do we need to take. Fear not, Jason Mikula explains all.

We've all heard the phrase buy a wonderful business, but how many us know what it means and how to find them. 10-k Diver teaches us how.

Moats, moats, moats, we all need to understand how they work, what makes them tick, and how they impact our investments.

Darwin can teach us far more about investing than you might think. Here, Giuliano explores specializations, such as Darwin's organs and Smith's labor, which enhance efficiency and explain ChatGPT's niche success.

🔍DEEP DIVE

Today, we will learn how to calculate the cost of capital or WACC.

WACC or cost of capital equals a discount rate for DCFs

Let's learn how it works.

WACC stands for Weighted Average Cost of Capital. It is a financial metric used to calculate a company's overall cost of capital, considering both debt and equity financing.

The WACC considers the proportion of debt and equity in a company's capital structure and calculates the average cost of each component weighted by its respective percentage.

The WACC or cost of capital acts as a discount rate or hurdle rate for DCF (discounted cash flows).

Here's how we calculate it:

WACC = (E/V) 𝘒𝘦 + (𝘋/𝘝) Kd * (1 - Tc)

Looks scary, but we will lay it out for you.

Where:

💰E/V represents the proportion of equity in the capital structure (equity value divided by total value).
💸Ke represents the cost of equity, which is the expected return demanded by equity investors.
💵D/V represents the proportion of debt in the capital structure (debt value divided by total value).
🤑Kd rep0.resents the cost of debt, which is the interest rate or yield required by debt investors.
💷Tc represents the corporate tax rate.

Ok, let's put this together using $MA as our example:

Total equity - $371,690
Total debt - $15,568
Cost of equity - 10.67%
Cost of debt - 2.59%
Tax rate - 18.2%
Weight of equity - 0.96
Weight of debt - 0.04

WACC = 0.96*10.67%+0.04*2.59%*(1-18.2%) = 10.33%

Using the above formula, we can calculate the WACCs of a some bigger companies for comparison:

$MSFT - 9.34%
$GOOG - 10.23%
$META - 11.17%
$V - 9.50%

The WACC considers the cost of debt and equity financing and provides a weighted average of these costs.

It reflects the minimum return a company must earn on its investments to satisfy its investors, both debt holders and equity shareholders.

It's important to note that calculating the WACC requires certain assumptions and estimates, such as the cost of equity and cost of debt.

These inputs can vary based on factors like the company's risk profile, market conditions, and the availability of historical data.