Buying a stock means buying a small piece of a real business. Good investors act like detectives: they gather clues about the business before they put any money in. This notebook teaches you the clues Warren Buffett uses, one at a time, with things you can try.
What a stock is and how money grows. Start here.
Imagine your friend Maya runs a lemonade business and splits it into 100 equal pieces. Each piece is called a share. If you buy 10 shares, you own 10% of the business. That means 10% of what it owns and 10% of the profit it makes.
Big companies work the same way, just with billions of shares. When people say "I bought Apple stock," they mean they bought a few of Apple's shares.
A few more words you'll see everywhere. Every company that sells shares has a short nickname called a ticker symbol. Apple's is AAPL. Nike's is NKE. Shares are bought and sold on a stock exchange, a big marketplace for shares. The two main ones in the U.S. are the NYSE (New York Stock Exchange) and the NASDAQ.
The total number of shares a company has handed out is its shares outstanding. Multiply that by the price of one share and you get its market cap: the price tag for the whole company.
A share is only worth buying if the business behind it is good. That's why the rest of this notebook is about the business, not just the price.
Read a company's clues like a pro: what it owns, what it earns, and what it's worth.
A balance sheet is a snapshot of a business on one day. It lists everything the company owns and everything it owes. Its master rule always balances:
Assets = Liabilities + Shareholders' equity
Assets: what it owns (cash, supplies, equipment). Liabilities: what it owes (loans, unpaid bills). Equity: what's left for the owners.
Warren Buffett has read thousands of balance sheets. He uses 5 rules of thumb to judge one in seconds:
| Rule | Clue | Detective note |
|---|---|---|
| 1 · Cash vs. debt | $20.8B vs $49.0B | FAIL More debt than cash. But it earns enough to pay its interest about 26 times over, so the debt isn't scary. |
| 2 · Debt-to-equity | 0.58 | CHECK This website figure uses debt only. Buffett's rule uses all liabilities, which gives a higher number. Look it up! |
| 3–5 · Preferred, retained earnings, treasury | ? | HOMEWORK Find J&J's latest annual report (10-K) and look in the shareholders' equity section. |
Revenue (also called sales) is all the money coming in. Profit is what's left after paying for everything. The profit margin tells you how many cents of every $1 in sales the business keeps.
A business that keeps 25¢ of every dollar can survive price wars and bad years much better than one that keeps 2¢.
J&J sold about $97.9B in a year and kept 21.5¢ of every dollar as profit. That's a high margin. Most stores keep under 5¢.
Growth is measured as a percentage per year. Small yearly growth adds up to huge numbers over time, because each year grows on top of the last. That's called compounding.
Investors use CAGR (compound annual growth rate), the average yearly growth over several years. Buffett's very first filter is whether a business is predictable: does revenue go up year after year, or jump around?
Revenue went from $79B (2021) to $98B (latest year), rising every year. That's slow, steady and predictable growth of roughly 4–6% a year.
Every public company is in one of five phases. Knowing the phase tells you what "good" looks like, and even how to value the company. A young company losing money can be normal. An old company losing money is a warning sign.
Phase 4. Slow steady growth, very profitable, and in the latest year it paid about $13B in dividends plus $8B buying back shares.
A castle has a moat so attackers can't get in. A business with a moat has something that stops rivals from stealing its customers. Without one, high profits attract copycats who cut prices until the profits are gone.
Five common kinds: switching costs (leaving is a pain), network effects (more users make it better), scale (biggest = cheapest), brand & patents (people trust it, or the law protects it), and counter-positioning (a new way of doing business the old players can't copy without hurting themselves).
Detectives ask two questions: how wide is the moat, and is it getting wider or narrower?
Phase 4 companies make more cash than they need, so they give it back to owners in two ways:
Dividends: cash paid straight to owners, usually every 3 months. A dividend yield of 2% means you get $2 a year for every $100 of stock.
Buybacks: the company buys its own shares (these become treasury stock, Buffett's rule 5 in The balance sheet). Fewer slices means each remaining slice is a bigger piece of the pie. But if the company also hands out new shares to employees, the slice count can still go up. That's called dilution.
Dividends: about $13B a year and rising (yield about 2%). Buybacks: about $8B, but its share count still went up, so the label is "yes, but diluting."
A stock's price alone tells you nothing. Is $100 a share expensive? It depends on what you get. A multiple compares the price to something the company earns, so you can compare fairly.
The most famous is the P/E ratio, or price ÷ earnings (profit). A P/E of 20 means you pay $20 for each $1 the company earns per year.
The phase decides which multiple works. P/E only works when a company is optimized for profit (phases 4–5). Younger companies are spending to grow, so their profit is tiny or negative. For them, you move up the income statement to a number that makes sense.
| Multiple | J&J | Meaning |
|---|---|---|
| Price / Earnings (P/E) | 30.3× | $30 for each $1 of yearly profit |
| Price / Free cash flow | 28.3× | $28 for each $1 of spare cash |
| Price / Sales | 6.4× | $6.40 for each $1 of yearly sales |
Buffett wrote that a business is worth all the cash it will hand out over its life, counted in today's money. That's its intrinsic value.
Why "today's money"? Because a dollar you get later is worth less than a dollar now. You have to wait, and you could have invested it in the meantime. So we discount future dollars.
Many investors turn this into a discounted cash flow (DCF) calculator: guess the future cash, discount it, add it up. But there's a twist. Charlie Munger, Buffett's partner, said at a 1996 meeting that he'd never actually seen Buffett do one. Buffett agreed and said that if the value doesn't scream out at you, it's too close to call. Try the calculator to see why.
Put the clues together and close the case.
Pick any company and rate each clue from 1 (bad) to 5 (great). The checklist won't tell you what to buy. It shows how strong your case is and which clues need more digging.