We help demystify the stock market and explain complicated subjects in plain language. Each Tuesday we send 6 Read by 21k+ readers weekly, including those from Visa, Wells Fargo, and Moody's.
đź’°Warren Buffett: How to Analyze an Income Statement
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Hey Reader, In today's issue:
💸Sponsored by: Tired of losing to the market? It's probably time to transform your portfolio. Get rich steadily—with stock picks hidden in plain sight, & too reliable to ignore. Featured monthly, only at Value Spotlight. 💎NUGGETS​ My Favorite Finds​ Brian Feroldi shows us how to analyze an income statement like Warren Buffett would (great stuff). Every company goes through a life cycle from young to over the hill, but precious few like Microsoft can remake themselves. Learn to spot the signs and how to value them. (of, course it's more Damodaran.) Thomas Chua helps us understand why we shouldn't fall in love with our stocks. The biggest investing question, what's it worth? Leandro breaks down some great ways to figure out the big question. Peter Lynch, the legendary investor, laid down some golden rules to help us become better investors (still working on that.) Terry Smith shared 10 Investing Lessons from Investing for Growth. Great book, great lessons. 🔍DEEP DIVE​ Breaking Down​ ROICCapital allocation is job number one for CEOs How we can measure capital allocation? Understanding ROIC is key. ​ Let’s learn more ⬇️ We will define the formula and inputs and briefly discuss why. Keep in mind that there are a gazillion ways to determine ROIC; this is my favorite. “A company creates value when the present value of the cash flows from its investments are greater than the cost of the investments. In other words, one dollar invested in the business becomes worth more than one dollar in the market.” Michael Mauboussin ROIC helps investors measure how effectively management reinvests the one dollar to grow beyond the initial investment. As with many metrics, the higher the better, and the longer the better. It is one way to measure how well management effectively allocates capital. So how do we calculate it? ROIC = NOPAT ÷ Invested Capital Where: 💸NOPAT = Net operating profit after taxes 💵Invested Capital = The net assets necessary to generate the NOPAT Let’s unpack NOPAT first, simplified. NOPAT = EBIT x (1 - tax rate) We can find both inputs on $MSFT’s income statement, with EBIT also equaling operating income. 💰EBIT = $83,383 million ⚖️Tax rate = 13.1% COST NOPAT = 83,383 x (1-13.1%) = $72,459 Easy, now the fun part. Now invested capital. First, we have several ways to calculate invested capital. We can approach it from the operating or financing side. Each has its benefits. I like operating because it forces me to look deeper into operations. Each to their own. Invested capital from an operations approach. Current assets - Non-interest bearing currrent liabilities = Net working capital
All of which gives us Invested capital. We can find all of this on the balance sheet: Net Working capital first​ +Inventory - $3,742 +Other current assets - $16,924 = Current assets of $64,927 Now current liabilities: +Accounts payable = $19,000 +Accrued comp = $10,661 +Short-term income taxes = $4,067 +Short-term unearned rev = $43,538 +Other current liabilities = $13,067 = Current liabilities of $90,333 Net working capital = 64,927-90,333 = -25,406 Then we take the net working capital and add the other inputs: +Net working capital = -25,406 +Net PP&E = 74,398 +Goodwill = 67,524 +Intangibles = 11,298 +Other assets = 21,897 Total Invested Captial = $148,711 Now we can put it all together to determine $MSFT ROIC 💸NOPAT = $72,459 💰Invested Capital = $148,711 ROIC = $72,459 ÷ $148,711 = 48.7% 📖Knowledge Tidbits​
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We help demystify the stock market and explain complicated subjects in plain language. Each Tuesday we send 6 Read by 21k+ readers weekly, including those from Visa, Wells Fargo, and Moody's.
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