If you had only 15 minutes to decide whether to invest your life savings in a business, what numbers would you look at?!
When Warren Buffett posed this question, everyone in the room fell silent.
Today we will discover what Warren Buffett would check if he only had 15 minutes to evaluate an investment.
1. Free cash flow
Imagine you have a lemonade stand.
Every day you earn $100 selling lemonade and spend $30 on lemons and sugar and $20 on wages.
This leaves you with a free cash flow of $50.
This is money you can reinvest to expand to another stand, return to shareholders, or save for a rainy day.
Now take Apple as a real-world example.
In 2023, they generated over $110 billion in free cash flow.
This massive cash generation allowed them to reward shareholders with dividends, buy back shares, and still have plenty of money left for innovation.
It's like having a money-printing machine that just keeps running.
2. Return on invested capital (ROIC)
Imagine two coffee shops.
Both earn $100,000, but coffee shop A required an investment of $500,000 to get there (20% ROIC), while shop B required $1,000,000 (10% ROIC).
Shop A is clearly more efficient at converting investment into profit.
Let's return to the real world – Visa is a perfect example of exceptional ROIC.
Their asset-light business model means they don't need to make massive investments in physical infrastructure.
However, they generate enormous profits from their extensive payment network.
Their return on investment often exceeds 20%, demonstrating their incredible efficiency in converting capital into profits.
3. Gross profit margins
Think of gross profit margins like a branded handbag.
If it costs $100 to produce the bag and it sells for $1,000, that's a gross profit margin of 90%.
High profit margins usually mean strong pricing power and a competitive advantage!
Returning to the real world, Microsoft's gross profit margins for Windows and Office are over 65%.
Why?
Because once the software is developed, selling additional copies costs nothing.
This demonstrates the power of their brand and their entrenched market position!
4. Customer satisfaction and loyalty
This is a super important metric!
It's a metric that measures the likelihood of customers recommending a product to others.
Think of Tesla in its early days – its customers were so enthusiastic that the company barely needed to spend on advertising.
Customer love translates into high pricing power and organic growth.
Costco is also an excellent example, with Costco club members (we previously posted a detailed article about Costco on the channel) renewing their memberships at a rate of 90%+ year after year – this tells you something powerful about their business model!
5. Revenue growth + profitability
This is where many investors get stuck...
Growth alone is not enough – anyone can grow by selling dollar bills for 90 cents.
Good things happen when a company can grow rapidly while maintaining improving profitability.
Look at Nvidia's journey!
Nvidia managed to significantly increase revenue during the AI boom while maintaining strong profit margins.
It's like a restaurant constantly opening new locations while improving food quality and raising prices – this is rare and valuable.
And that's what we should be looking for!
Strong gross profit margins provide cash for innovation and marketing.
This leads to satisfied customers who remain loyal to the brand and tell others about it.
The business can then grow while maintaining a high ROIC, generating more free cash flow to reinvest or return value to shareholders.
This cycle, when it works, is a virtuous business cycle.
But, pay attention:
These numbers do not stand alone – they must be considered in a broader context:
A company with growing profit margins but declining cash flow could be in trouble.
And a company with low profit margins but exceptional growth and improving efficiency could be a hidden gem.
Let's conclude with the famous quote Charlie Munger said on the same topic:
If you can't read these basic numbers (everything we mentioned in the post), you have no business in the world of investing – you'd better go to the movies instead...