Learn to invest with Buffett

Chapter 29

Chapter 5 Learn from Buffett and see through the mystery behind the numbers behind the rise and fall of stocks
Chapter 5, Section 1 Return on Net Assets: The best indicator to measure the size of an enterprise’s operating capabilities

In the short run, we generally consider the ratio of operating profit (excluding gains and losses on the sale of securities) divided by shareholders' equity (at original cost) to be the best measure of operating performance for a year.

--Warren Buffett
Buffett believes that the best indicator to measure the size of a company's operating capabilities is not the increase in earnings per share, but the return on net assets.The so-called return on net assets, also known as return on shareholders' equity, is the percentage of net profit to average shareholders' equity.

Net profit refers to the company's profit retention after paying income tax according to the regulations in the total profit, which is generally also called after-tax profit or net income.The formula for calculating net profit is: net profit = total profit × (1 - income tax rate).The size of the net profit depends on two factors: one is the total profit, and the other is the income tax rate.The corporate income tax rate is statutory, and the higher the income tax rate, the lower the net profit.There are two kinds of income tax rates in our country. One is the income tax rate of 33% for general enterprises, that is, 33% of the total profits should be turned over to the state finance as tax; the other is the preferential tax rate adopted for foreign-funded enterprises and some high-tech enterprises. The rate is 15%.When the operating level of enterprises is the same, the operating efficiency of enterprises with lower income tax rate will be better.Net profit is the final result of a business operation.If the net profit is large, the operating efficiency of the enterprise will be good; if the net profit is small, the operating efficiency of the enterprise will be poor.It is the main index to measure the operating efficiency of an enterprise.For enterprise investors, net profit is the basic factor to obtain the size of return on investment, and for enterprise managers, net profit is the basis for business management decisions.Net profit is also a basic tool for evaluating a company's profitability, management performance and debt-paying ability, and is a comprehensive indicator that reflects and analyzes various aspects of a company.

Shareholders' equity, also known as net assets, refers to the remaining part of the company's total assets after deducting liabilities.Shareholders' equity includes the following five parts: one is share capital, which is the share capital calculated according to the face value; It is the statutory surplus reserve and the discretionary surplus reserve.Statutory surplus reserve is withdrawn at 10% of the company's after-tax profits.The purpose is to deal with business risks.When the accumulative amount of the statutory surplus reserve reaches 50% of the registered capital, it can no longer be withdrawn; the fourth is the statutory public welfare fund, which is withdrawn at 5% to 10% of the after-tax profit and used for the company's welfare facilities; the fifth is the undistributed profit, which refers to The profit reserved by the company for distribution in the following years or the profit to be distributed.The formula for calculating shareholders' equity is: shareholders' equity = total assets - total liabilities.Shareholders' equity is also a very important financial indicator, which reflects the company's own capital.When total assets are less than liabilities, the company is in a state of insolvency, and the company's shareholders' equity disappears.If bankruptcy liquidation is implemented, shareholders will get nothing.Conversely, the larger the amount of shareholders' equity, the stronger the company.

ROE reflects management's operating efficiency with capital invested by shareholders.The higher the return on net assets, the faster the growth of the company's shareholders' equity, and correspondingly, the company's intrinsic value will also grow steadily.Concentrating on investing in excellent companies with a high level of return on net assets is the secret of Buffett's investment success.

Investment motto:

When investors are looking for companies to invest in, they must pay attention to the indicator of return on net assets.Investors should try their best to choose enterprises with high return on net assets.A company with a higher return on net assets can bring more substantial returns to investors.

(End of this chapter)