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
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.