In an interview with Warren Buffett in 1993, Adam Smith, author of Supermoney, asked how the small investor can find good investment ideas.
Warren Buffett: I’d tell him to do exactly what I did 40-odd years ago, which is to learn about every company in the United States that has publicly traded securities, and that bank of knowledge will do him or her terrific good over time.
Adam Smith: But there are 27,000 public companies.
Warren Buffett: Well, start with the A’s.
Everybody knows that Warren Buffett gets his investment ideas largely from annual reports.
Of course, now he has become so influential that companies call him to share their own ideas. But, fifty years ago, Buffett was not the go-to guy if you wanted to sell your company or raise capital for your failing bank.
He was a small investor who was clawing his way up the investing street by reading whatever annual report came his way, and then finding his investment ideas that worked wonders in the subsequent years.
You are probably at the same stage Buffett was fifty years ago. But there’s a big advantage you have over the early day Buffett.
Your big advantage over early Buffett
That’s ‘technology’!
With annual reports now available at the press of a few buttons (on company websites and BSE), you can look through hundreds of companies in lesser time than it took Buffett to access ten companies.
“But who has the time to read through hundreds of annual reports, with each report exceeding 100 pages?” you may ask.
Nice question, but there’s a simple secret I’ve been following to run through an annual report in one minute (yes, just 1 minute), and then deciding whether the company is worth looking into or not.
The 1-minute secret to finding good stocks
While there is much more to a company than its financials, starting with the financials – and especially the Balance Sheet – will allow you to quickly dismiss hundreds of company instantly.
Over the past ten days, I’ve looked at more than 15 companies and found only one potential investment – a great company that is overpriced (obviously, I’m waiting until it drops 20-25% or so).
As an example of companies that can be “glossed over and discarded” in less than 1 minute, look at this balance sheet of Tata Teleservices Maharashtra:
Source: TTML’s Annual Report
After glancing through this Balance Sheet, I know I don’t need to do a thing but close the file and move on. The worst part was that I had to wait a minute while the page loaded on my computer.
Another example is this balance sheet of Suzlon:
Source: Suzlon’s Annual Report
Bad Balance Sheet = Bad Business
It is as simple as that!
Out of 100+ businesses that I’ve studied over the past three months, I’ve been able to immediately discard 80% or so because of their negative balance sheets.
This is because when a company has a weak balance sheet, everything else about it is often highly unstable.
The remaining 80% of the businesses were discarded in under a minute or two. Ordinary balance sheets, poor cash flows, and bad return ratios were the primary reasons for passing them off.
With such weak foundations and such poor past performance, I didn’t need to spend any time figuring out where these businesses would be in the future.
Thus, to get through 100 or so companies took about a few minutes a day for the past three months, with just a few having moved to the “do more research” list.
If you don’t have a few minutes a day
See, you don’t have to look at every listed company out there.
In fact, you can make very good returns by sticking with known brands when they are selling at a discount.
But, if you want to spend some time taking your investing and returns to the next level – if you want to “start with the A’s” as Buffett suggests – glossing over the annual reports is the first step.
And remember, just 1 minute a report findeth a good stock.
Nice article Vishal, especially what Buffett said in the beginning “Start with A’s”. I am from the non-financial background, I would love to read an article explaining the Balance Sheet, Financial Statement, P&L Statement etc. Please do a post on that if and when you get time.
Also, articles on various financial ratios and how they are important.
Am I asking for too much 🙂
Thanks Mansoor! No, what you are asking is what other avid readers of Safal Niveshak also want me to do 🙂
So, I’m already working on a series on the financial statements and you’ll soon find that on Safal Niveshak.
a good quick litmus test.
vishal,
while tata tele and suzlon is definitely not qualify for investment but looking from financial angle, tata tele is not so bad. Debt is not so high when compared with networth and gross block. See the accumulated depreciation. If you remove accu.depn from accu P& L debit balance, loss is minimal.
Cash Management seems to be good with less cash balance which is justifiable in the light of negative working capital.
Net effect, the company’s problems seems to be temporary and probably on the verge of turning around. Let us see.
IMO buffett’s principles have to be modified for indian environment as there is vast difference is accounting and preparation of financial statements.
Hi Sri,
Thanks a lot for your comment and observation!
However, TTML’s balance sheet has been bad for the past few years. Including accumulated losses, its Equity has been negative for the past 7 years, while debt has been on a consistent rise. Of course, the company has a negative working capital, a large part is the money that is due to its customers. I would’ve been happier if a large part of this negative working capital would’ve been ‘advances from customers’, but that’s not the case. Also, the real value of its fixed assets is lower than the balance sheet value given that their replacement value is considerably low (largely due to obsolescence).
So the company’s problems don’t seem temporary, and may continue to worsen given the state of the telecom industry and the high capex requirements that the company faces.
Regards,
Vishal
Dear Vishal..
Nice one and really useful… Whether this logic will be applicable to Finance and Banking companies,,
Thanks for the feedback, Karthik! Well, I am no expert in banking companies, but given whatever little I understand, look at the NPAs and whether they are rising in a bank’s balance sheet. It will give some indication about the bank’s future.
Dear Vishal,
You make those stock picking (rather rejecting a stock) look so simple.
How to read the quaterly analysis? Is there any simple way to check that? How can we find the reasons why the Operating Margins are reduced or similar issues, that affect the price of stock?
Can we get any lessons from Deccan Chronicle Stock? How do we ensure the cash they show in their balance sheet is a real cash available with the company? Actually IPL and Oddessy stores were projected by the investment analyst as a huge hidden value in DC.
Can you write in detail about the lessons to be learned from DC!
Regards
When is your next workshop in chennai
Hi Raj, the next Workshop in Chennai may be in March-April 2013.