Wednesday, January 4, 2012

Book Review: Warren Buffett and the Interpretation of Financial Statements

On the advice of a friend, I just recently purchased a book on how to read and interpret financial statements (income statements, balance sheets, and cash flow statements) for publicly-traded companies. Since I wanted to learn how to read these statements in the context of Warren Buffett's style of investing, I found the perfect title: Warren Buffett and the Interpretation of Financial Statements: The Search for the Company with a Durable Competitive Advantage.

The book is a short one, weighing in at only 175 pages of reading. It also includes appendices containing model financial statements, an index, and a particularly useful glossary that not only defines a list of financial terms, but also explains the term's significance when it comes to finding signs of a durable competitive advantage in a company. The book goes through each type of financial statement, line by line, and explains its meaning, possible abuses, and usefulness in determining the health and advantages of a company. After each financial statement is covered, the book also has a few chapters on valuation of stocks, Buffett's equity-bond theory, and when to buy and sell a stock in Buffett style.

Overall, I've found this to be a helpful book that has expanded my knowledge of fundamental analysis of companies. It was an easy and informative read; I ended up finishing it in under 24 hours (which is saying a lot for me!) After reading the book, I summarized what I had learned by skimming each chapter over again and creating a Word document that contains a checklist of things to look for in financial statements when searching for whether a company has a durable competitive advantage.

I currently only own one stock position (it's been almost 4 months since I bought it) that I had researched a fair amount at the time of purchase. Armed with my new and deeper knowledge of financial statements, I did another analysis of the stock's financial statements based on my new checklist. Happily, the stock passes nearly all the line items on my checklist. This has renewed my resolve to hold on to the stock for a long period of time. However, good financials and a bargain price are not the only things Buffett relies on to become so wealthy. Warren Buffett is a believer in investing inside one's own "circle of competence", or "invest in what you know". The stock I own is a uranium mining company. Admittedly, I know very little about uranium mining, the accompanying industry, competition or external factors that can influence the company whose shares I own. In any case, I will hold on to my stock regardless and hope for the best, but in the future I plan on investing within my circle of competence. As Warren Buffett once said, "You don't have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital."

Coming back to the book review, I would definitely add this book to my list of recommended reading. It remains to be seen how financially beneficial this book will be to me in the future, but my guess is that it will be greatly valuable.

To buy the book from Amazon, click the link below. If all you can see is an Amazon ad, just refresh this page. Disclaimer: If you do so, I will earn a small commission.