Seven Buffett-Style Income Statement Checks
How does Warren Buffett glance at an income statement and spot a great business? Here are seven simple checks — no fancy talk, just easy math.
First, what's an income statement? It's a company's report card: sales at the top, costs pulled out step by step, profit at the bottom.
Berkshire Hathaway's own buying checklist asks for steady earning power, good returns on equity with little or no debt, and simple businesses.
But here's the thing: Buffett has never published the seven exact cutoffs below.
They come from Brian Feroldi's popular Buffett-style video, so treat them as screening clues — not rules Buffett signed off on.
One more heads-up, straight from the SEC: desirable ratios vary by industry, so always compare a company with its own kind.
1. Check the Gross Margin First
Gross margin is the slice of each sales dollar left after paying the direct cost of making the thing that was sold.
Picture a lemonade stand: sell a cup for $1, spend 50 cents on lemons and sugar, and your gross margin is 50%.
The clue here is a steady gross margin above 40%, because a wide gap between cost and price often means the company can charge more without losing customers.
In company numbers: $100,000 of revenue minus $50,000 of cost of goods sold leaves $50,000 of gross profit — a 50% gross margin ($50,000 / $100,000).
How to Find It:
- SEC EDGAR — the government's free search box for every public company's official filings.
- Open the 10-K (the big annual report), figure (revenue − cost of sales) ÷ revenue, then compare a few years and a few close rivals.
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2. Weigh the Overhead Next
Selling, general, and administrative costs — SG&A for short — are the bills for running the store, not making the goods: ads, offices, salespeople, managers.
This framework flags SG&A above 30% of gross profit, since lean overhead leaves more profit behind.
Don't panic over one high year, though — extra spending can fund growth or a strong sales team.
If gross profit is $200,000 and SG&A is $40,000, the ratio is 20% ($40,000 / $200,000). Easy, right?
How to Do It:
- The SEC's beginners' guide to financial statements — a plain-English map of every line on an income statement.
- Divide SG&A by gross profit in the 10-K, then check several years: is the share steady, rising, or falling?
3. Put Research Spending in Context
Research and development — R&D — is the company's workshop budget: money spent inventing new products and technology.
Divide R&D by gross profit and use 30% as a rough line, because a business that must constantly reinvent itself has a harder, riskier job.
Heavy research isn't automatically bad — in fields like technology and medicine, it's the whole game.
If gross profit is $150,000 and R&D is $15,000, that's 10% ($15,000 / $150,000).
How to Find It:
- SEC EDGAR — the official place to pull a company's 10-K and its fine print.
- Search the filing for "R&D" or "product development," divide by gross profit, and compare similar companies over several years.
4. Test the Weight of the Debt Payments
Interest expense is rent on borrowed money — the fee a company pays just for carrying its debt.
The clue here is interest below 15% of operating income (the profit from normal business, before loan costs and taxes), because a light debt load leaves more profit for owners.
With $80,000 of operating income and $4,000 of interest, the ratio is 5% — flip it around, and profit could pay the interest bill 20 times over.
Quick note: Berkshire's 2014 letter measures coverage its own way — pre-tax earnings divided by interest — so don't mix the two formulas.
How to Do It:
- SEC EDGAR — the same free filing database — has the income statement lines plus the debt notes with rates and due dates.
- The Berkshire letter linked above shows Buffett's own coverage math if you want to run both versions.
5. Compare the Tax Rate to 21%
The effective tax rate is the slice of profit that goes to the tax man: tax expense divided by pre-tax income.
If pre-tax income is $60,000 and tax expense is $12,000, the rate is 20% ($12,000 / $60,000).
Why care? Most U.S. companies face a 21% federal rate, so a rate that sits far below that year after year deserves a closer look.
It isn't automatically shady — state taxes, foreign income, credits, and deferred items all move the number — but you want to know the reason.
How to Find It:
- IRS Form 1120 instructions — the official source for the current 21% corporate rate.
- In the 10-K, divide tax expense by pre-tax income, then read the tax footnote for the why.
6. See How Much of Each Sale Becomes Profit
Net profit margin is the final slice: the share of every sales dollar left after every single bill is paid.
Look for more than 20%, since fat margins usually mean the company has an edge its rivals can't copy.
Normal margins differ wildly by industry — a grocery store lives on thin slices, a software firm on thick ones — so compare like with like.
If revenue is $500,000 and net income is $125,000, net margin is 25% ($125,000 / $500,000).
Strong margins alone don't make a stock a buy, so our guide on spotting a bargain versus a trap is a smart next read.
How to Do It:
- Use SEC EDGAR — the free official database — to open the latest 10-K.
- Divide net income by revenue, then line the answer up against the company's own history and its rivals.
- Benjamin Graham's classic — Buffett calls it the best investing book ever written
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- Jason Zweig's commentary ties each chapter to modern markets
7. Track Earnings Per Share Over Time
Earnings per share — EPS — is the profit pie cut into slices, one slice for every share of stock.
You want EPS positive and rising over many years, because a business that earns more per slice is usually getting stronger.
One warning: buybacks, new shares, and one-time windfalls can all move EPS without the business improving — so judge the trend, not one year.
A quick example: $900,000 of net income spread over 100,000 shares is $9 of EPS.
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How to Find It:
- The SEC's guide — shows exactly where EPS sits on an income statement.
- Write down basic and diluted EPS (diluted counts extra shares that could exist), plus net income and share counts, for several years.
Wrapping Up
Think of these seven checks as dashboard lights — they tell you where to pop the hood, not whether to buy the car.
Numbers are only half the story, so the investing habits Warren Buffett wants you to question make a good companion read.
And remember: these are research ideas, not personal instructions or individualized financial advice.
The Numbers Talk. Benjamin Graham Teaches You to Listen
Five Minutes, One Stock, No Guesswork