Return on Sales – LUCKY IDIOT

Mr.Buffett has taught us –

Never count on making a good sale. Have a purchase price be so attractive that even a mediocre sale gives good results. The better sales will be the frosting on the cake.

Our business is making excellent purchases – not making extraordinary sales.

Mr. Buffett believes that big money can be made by making investment decisions based on qualitative factors whereas sure money can be made by making investment decisions based on quantitative factors. And hence, on the basis of this; he considers himself as a quantitatively focused investor.

The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share.

Business must have two characteristics: (1) an ability to increase prices rather easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of either market share or unit volume, and (2) an ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital.

Many a time, management only focuses on the increasing future Earning Per Share (EPS) by sacrificing the strength of the balance sheet. But they forget that if the balance sheet does not remain strong for a longer period of time then business is going to have a tough time into the future.

Accounting numbers, of course, are the language of business and as such are of enormous help to anyone evaluating the worth of a business and tracking its progress. Charlie and I would be lost without these numbers: they invariably are the starting point for us in evaluating our own businesses and those of others. Managers and owners need to remember, however, that accounting is but an aid to business thinking, never a substitute for it.

“What we learn from history is that we do not learn from history.”

Any company’s level of profitability is determined by three items: (1) what its assets earn; (2) what its liabilities cost; and (3) its utilization of “leverage” – that is, the degree to which its assets are funded by liabilities rather than by equity. Great companies = Float + Investment + Cash with higher return ratio

If the choice is between a questionable business at a comfortable price or a comfortable business at a questionable price, we much prefer the latter. What really gets our attention, however, is a comfortable business at a comfortable price.

Buy commodity, sell brand has long been a formula for business success.

Capital-intensive business, look for PBT / interest cost rather EBITDA / interest cost.

When we are fearful with our investment decisions then we focus on the each and every aspects which can result in the erosion of the capital.

Mr.Buffett has taught us many concepts and wisdom which is essential to us while making an investment decision. I am hereby compiling all my learning from the letters of Mr.Warren Buffett. Also an evolution of Mr.Buffett from bargain to quality businesses.

For all in one learning from Mr.Warren Buffett’s Letters, Click here –> BIBLIOPHILE WARREN BUFFETT’S LETTER 1957-2017

I am really grateful to Riddhi for helping me with editing work.

WB Letter 1976

Performance of the company has shown significant improvement in the year 1976 and company has been able to achieve 17.30% returns on shareholders’ equity.

Textile operation

Return on sales and Return on capital employed of textile operations was inadequate due to sluggish industry condition. Performance of any company can be measured by looking at the return on sales and return on capital employed and whether the business has a temporary problem or not.

Insurance operation

In the year 1976, insurance underwriting business has shown good performance due to the increase in the premium rates.

WB Letter 1977

People measure higher earnings per share on the basis of the past record-breaking earnings but according to Mr.Buffett, if the company issued 10% additional equity capital and if due to that there is an increase in earnings per share by 5%; then it is not considered a good performance. He mentioned that rather focusing on the higher reported earnings per share, we should focus on the return on equity capital (I.e. RoE).

Textile operation

Textile operations once again were reported as poor earning in the year 1977. Mr.Buffett gave a reason to the shareholders for remaining into the textile business.

WB 1977 01

Insurance operation

Mr.Buffett quoted the shifting of a pendulum from good period to the worst period –

WB 1977 02

He mentioned his investment criteria as –

WB 1977 03

WB Letter 1978

Diversified Retailing Company got merged into the Berkshire Hathway and due to this merger; holding of Berkshire into the Blue Chip Stamps increased to ~58%.

Textile operation

When a product is indifferentiated and business is capital intensive in nature, we earn inadequate return whereas we can earn above-average returns during a tight supply or shortage of product.

WB Letter 1979

Investment into equities shares carried out till 1979 at the lower of aggregate cost or market value. But from the year 1979, the accounting profession has decided to carry out investment at the market value.

Mr.Buffett has mentioned “Return on Capital Employed” as the criteria for measuring managerial performance.

WB 1979 01

A few years ago, Mr.Buffett had decided to purchase a Waumbec Mills in Manchester, the stock was available statistically cheap, well below the working capital of the business and, in effect, got very substantial amounts of machinery and real estate for less than nothing. But this decision resulted into the poor performance and faced too many difficulties to manage the business. Due to this experience, Mr.Buffett communicates an effective point to understand –

WB 1979 02

According to Mr.Buffett, we should focus on the management who utilize retained earnings effectively and will translate a dollar retained by them into a dollar or more of subsequent market value for us.

Mr.Buffett recognized his mistake in buying a bond and he had accepted this in front of his shareholders.