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The purpose of looking at financial reports is to analyze the strengths and weaknesses of a listed company.#

Some tips for financial reports include analytical frameworks and useful tools. The purpose of looking at financial reports is to analyze the strengths and weaknesses of a listed company. There must be criteria for judgment, and these criteria are hidden in the financial reports.

The "Balance Sheet," "Income Statement," and "Cash Flow Statement."

The "core indicators" in these three statements can directly reflect the strengths and weaknesses of a listed company.

Therefore, what you need to do when reading financial reports is to interpret the core indicators and produce qualitative conclusions.

Seventeen commonly used "core indicators" have been filtered from the financial data and categorized into five dimensions. A table has been created:

Focus on the "explanation and notes" for each indicator.

The ultimate goal of the five dimensions—cash flow, operational capability, profitability, financial structure, and debt repayment ability—is to clarify a company's situation regarding "assets, liabilities, and cash."

Assets are soft, liabilities are hard, and cash is king. This saying can be well understood and applies equally to individuals.

4. How to use these indicators?

First, from the perspective of "a company," the levels of indicators can indicate good or bad.

Indicators like gross profit margin, net profit margin, current ratio, and quick ratio are definitely better when higher.

However, the cash-to-total-assets ratio and the shareholder equity-to-total-assets ratio should be moderate.

If the cash-to-total-assets ratio is too high, cash flow may be abundant, but cash does not generate returns for shareholders.

If the shareholder equity-to-total-assets ratio is too high, the company's leverage is too low, and operations are not active enough.

Secondly, from the perspective of "an industry," conduct horizontal comparisons among different companies within the same industry. Companies in the same industry have similar business models, and comparing their gross profit margins, net profit margins, inventory turnover days, and accounts receivable turnover days can give a rough idea of which companies are more outstanding.

When making investment decisions, in addition to looking at "financial indicators," one must also consider "valuation indicators."

This means comparing the PE, PB, and percentiles of different companies within the same industry. If a company's financial data is below the industry average while its valuation indicators are higher than those of other companies, it is advisable to avoid it. Additionally, comparing the financial data of different companies within the same industry can help identify "fraudulent companies."

Every industry has one or several leading enterprises.

Leading enterprises possess rich management experience and strong channel control. Their gross profit, net profit, inventory turnover days, etc., generally represent the current ceiling of the industry. If a newly established company has better gross profit, net profit, and inventory turnover days than the leading company, then the financial data may be inflated.

Finally, if after analyzing several companies in an industry, the data looks poor—such as low gross profit, long business cycles, and several years of negative OCF—then the industry is likely facing problems.

First, be patient and observe. Is it meaningful to look at financial data right away? It is pointless if you don't understand the business behind the data. From top to bottom: Do you understand the current situation and basic rules of the industry in which the company operates? Broker research reports can help with this. Do you understand the company's main business? Broker research reports, the company's official website, and analysis articles can help with this.

Do you understand the changes in the company's business during the reporting period?

The "Management Discussion and Analysis" section in the financial report can provide answers.

Second, look wisely. Financial data is never seen directly in the financial report because the raw data is all numbers, and people are naturally not sensitive to numbers. Therefore, use tools to view processed, visualized financial data. What tools to use?

There are many, such as Xueqiu, Li Xingren, Luobo Investment Research, Choice, and others. They are quite similar; just use what you are comfortable with.

Third, look dialectically. Financial data is a financial language, while understanding a company requires a business language, necessitating the integration of both languages in your mind. How to do this? Deeply understand the business significance behind the "main financial indicators":

Key points for reading financial reports: understand the business, use tools, and understand the indicators.#

The financial report includes three aspects: the audit report, the accounting statements, and the notes to the accounting statements. Here, we will focus on the accounting statements, and the core of the accounting statements is the three statements:

Balance Sheet, Income Statement, Cash Flow Statement.#

To understand financial reports, the core is to understand these three statements.

1. Income Statement: See how much money a company makes.
   First, let's look at the income statement, which shows the company's profitability during a period. We can examine two typical indicators:

Speed of making money—Operating Income, Net Profit

First, we can assess a company's growth speed from operating income and net profit. A simple method is to compare this year's operating income and net profit with last year's to see the growth rate. Taking Kweichow Moutai and Yanghe Brewery as examples, the data shows that Moutai's growth capability is strong, surpassing the latter.

Efficiency of making money—Gross Profit Margin
Additionally, we can see how efficient a company is at making money from the income statement. Simply put, it indicates whether the company can make a profit. This ability is generally measured by the gross profit margin. What is the gross profit margin?
Taking a restaurant as an example, if the operating income in 2016 is 100,000 and the cost of goods sold is 50,000, then the gross profit is 100,000 - 50,000 = 50,000, and the gross profit margin is (100,000 - 50,000) ÷ 100,000 = 50%. This 50,000 still needs to be reduced by labor, utilities, and other expenses to determine the actual profit. Therefore, if the gross profit margin is too low, the restaurant may incur losses. Generally, good companies have a gross profit margin of no less than 30%. Otherwise, after deducting taxes, management fees, and other expenses, they may not make much net profit.
Similarly, let's calculate the gross profit margins of Kweichow Moutai and Yanghe Brewery.

2. Balance Sheet: See if a company is safe.#

The balance sheet, as the name suggests, has two main components: assets and liabilities. Assets refer to things that a company owns that have commercial or exchange value and are expected to bring economic benefits or resources in the future. For example, cash, factories, and machinery are typical assets; liabilities refer to debts that a company incurs that can be measured in monetary terms and will be repaid with assets or services. This statement primarily reflects a company's financial strength at a specific point in time. Here are two important pieces of information.

Debt-to-Asset Ratio#

Generally, reasonable corporate debt is aimed at better operating production and enhancing competitiveness. Reasonable borrowing is also a good choice for companies. However, having too much debt is always risky; if unable to repay, it could lead to bankruptcy, so companies with high debt are always dangerous.
How do we judge whether a company's debt is reasonable? The simplest method is the debt-to-asset ratio, which is total liabilities ÷ total assets.

Debt-to-Asset Ratio = Total Liabilities ÷ Total Assets
Generally, the debt-to-asset ratio varies significantly across industries. However, it is best not to exceed 50% and ideally not exceed 60%. For example, both Moutai and Yanghe have debt-to-asset ratios around 30%, indicating a low debt burden.

In addition, we should pay close attention to the overall borrowing rate of the company, which is the cost of debt. By focusing on interest expenses and related sections in the financial statements, we can find relevant information. The more a company can borrow at low costs, the more valuable the debt becomes.

*Asset Turnover Ratio
Next, let's introduce an important reference indicator—the asset turnover ratio. This indicator can correspond to different specific asset turnover ratios, such as accounts receivable turnover ratio, inventory turnover ratio, etc. The main value of these turnover ratios is to reflect the operational efficiency of the company.
Let's take the accounts receivable turnover ratio as an example. The balance sheet has an item called accounts receivable, which refers to the money owed for goods sold but not yet received.

Accounts Receivable Turnover Ratio = Operating Income (from the income statement) ÷ Average Accounts Receivable.
How do we understand this indicator?

Assuming there is a regular customer who comes to your restaurant every month and eats for 100 yuan on credit, paying at the end of the month, then this person spends a total of 1200 yuan a year, while this credit keeps 100 yuan as accounts receivable. Calculating gives an accounts receivable turnover ratio of 1200 ÷ 100 = 12, meaning accounts receivable turns into cash 12 times a year.
If this person settles the bill once a year, the accounts receivable turnover ratio would be 1200 ÷ 1200 = 1.

Thus, the lower the accounts receivable turnover ratio, the longer the collection period, and the slower the recovery of accounts receivable; conversely, the higher the turnover ratio, the shorter the collection period, and the faster the recovery of accounts receivable. This means that generally, the higher this indicator, the better.

Both companies have positive operating cash flow, and relatively speaking, Yanghe's cash flow is healthier than Moutai's.
In addition to operating cash flow being generally better when positive, the positive or negative nature of investment and financing cash flows is hard to determine which is better; we also need to analyze it in conjunction with the company's development stage, industry, and other specific information.
Finally, I remind everyone that some important data can also be found in the notes to the accounting statements, so it is worth reviewing selectively.
Alright, let's summarize the content of this lesson:
Previously, we mentioned that stocks represent a portion of ownership in a company, and fundamental analysis aims to select a good company in a good industry when its stock price is undervalued, thereby increasing our investment success rate.

Specific analysis includes both quantitative and qualitative analyses. We need to establish a manager's perspective to examine the company. A simple model is to use the SWOT analysis method to comprehensively analyze multiple factors for qualitative analysis.

From the data in the financial statements, we quantitatively analyze a company. You can mainly focus on the three most important tables: the income statement, balance sheet, and cash flow statement. We have also compiled a table of some important points for your reference, which you can find in the handout section.

What is the relationship between business logic and the three financial statements?#

From this table, we can see that the establishment of a company is either through "investor input" or "borrowed funds from creditors." The invested and borrowed funds can form the company's "assets."

However, assets are a resource that needs to be invested, and this investment involves the company's overall strategy.

To explain, a company actually has two ways to make money:
One way is through self-operation, i.e., purchasing a bunch of inventory, building a factory, designing some patents, and then operating it independently. The other way is to invest or put money into the stock market, simply put, not doing it themselves but investing the money received into other companies or buying stocks, not self-operating. These two ways of making money determine that a company's assets can be divided into two major categories:

One is "operating assets," and the other is "investment assets."

For example, if I want to establish a company and I invest 1 million yuan, then I have 1 million yuan in owner's equity. Meanwhile, to expand my total assets, I can use the 1 million yuan in equity as collateral at the bank and possibly borrow 300,000 yuan from the bank. The borrowed money from the bank is actually my debt. Therefore, owner's equity and liabilities constitute a company's assets. The assets of this company are actually the resources it can utilize.

The resources of the aforementioned company are 1.3 million yuan, but this 1.3 million has two sources: 1 million from the investor's input and another 300,000 from the bank's borrowing.

Once the company has assets, what should it do? There are two choices.
The first choice is to allocate a large portion of resources for self-operation, so the assets can be allocated as operating assets.

The other choice is to invest these assets. Perhaps dividing the 1.3 million into ten small parts, each 130,000 yuan, to invest in some startups. If one startup succeeds, it can also generate profits. The assets can also become investment assets.

When a company has "operating assets," it must conduct business, and this business must generate income. To generate this income, it will also incur corresponding "expenses and costs."

The difference between income and expenses is the profit generated by the company's operating activities, which I call "core profit."

"Investment assets" will bring "investment income." The core profit generated by a company from its operations and the investment income generated from investments together constitute the company's "operating profit." Once there is profit, it needs to be distributed as dividends or used to repay debts, so in the above diagram, you can see a blue line indicating profit directed towards creditor borrowings and investor inputs.

"Core profit" is usually not shown in financial reports because operating assets correspond to the operating profit according to the original financial standards. However, since the current financial reports include not only the profits generated by operating assets but also investment income, a new term called "core profit" has been created specifically to correspond to the profits generated by operating assets.

With the blue part of the balance sheet and the purple part of the income statement, there is also a particularly important "cash flow statement," which is the brown part in the above diagram.
The company's resources are obtained in cash form, leading to "financing cash inflows." A company's assets need to be invested externally, so they are invested in its operating assets.

For example, it can invest in fixed assets or other enterprises, which are investment assets. Therefore, there will be "investment cash outflows" as shown in the diagram.
Operating assets will generate income, and if we can receive cash from this income, it will form "operating cash inflows." To achieve this income, there will certainly be some expenses and costs, and if these expenses and costs require cash payments, it will generate "operating cash outflows."

The net amount of cash inflows and outflows from operating assets forms the "net cash inflow from operating activities." If investment assets can generate investment income, and if the income is realized in cash, it becomes "net cash inflow from investments."

When a company has both operating cash inflows and investment cash inflows, it will consider repaying debts. Once debts are repaid, "financing cash outflows" will occur, whether in the form of dividends or cash payments, which also counts as "financing cash outflows."

Through this table, I hope to connect a company's main business model and operational model with accounting. The blue part represents the balance sheet, the purple part represents the income statement, and the brown part represents the cash flow statement.

Accounting information is divided into three parts:
First, the balance sheet, the most important equation of which is:
Assets = Liabilities + Owner's Equity, which is one of the two equations to remember.

Second, the income statement also has an equation: Revenue - Expenses = Profit, which forms the structure of the balance sheet and income statement.

The third is the cash flow statement, which includes operating cash flow, investment cash flow, and financing cash flow.

What is the difference between accounting and finance?#

What do the three financial statements in accounting information reflect about a company? Which statement is the most important? We need to address these questions first.
First, the income statement reflects a company's capability because it is based on effectiveness.
Generally, "you manipulated profits in this company" is a common statement, but rarely do people say "you manipulated assets in this company." Why? Manipulating profits often reflects insufficient capability; since there is insufficient capability, better profits are needed to compensate for the incompetence displayed. Therefore, a company's income statement reflects its capability.
A company's cash flow statement reflects its vitality. Having good cash flow is the foundation for a company to maintain its vitality, allowing it to "do whatever it wants."
As I mentioned earlier, if your company indeed has profits but no cash flow, then it can't do anything; having a pile of accounts receivable is actually useless.
Of course, you might say, "I can monetize it through supply chain finance," but the costs are very high.
Thirdly, the balance sheet reflects a company's strength.
For example, if there are two companies, Company A has 1 million yuan in assets and also 1 million yuan in profits; another Company B has 100 million yuan in assets but only 1 million yuan in profits. When evaluating the two companies, you might think Company A seems to be more profitable, but its strength is not as good as that of Company B, which has 100 million yuan in assets. We often say, "Your company is very strong," which actually refers to how much asset this company has.
Which of the three statements is the most important? From observing their history, we can know.

From another perspective, what is the income statement? The income statement actually reflects a subject in the balance sheet, called the change in retained earnings; the cash flow statement merely reflects a subject in the balance sheet, which is the change in cash.
From this perspective, the balance sheet is the core of the three statements, so when we conduct financial statement analysis, we should start with the balance sheet.

What is the most important item in the balance sheet?
Another very important point is that in financial statements, such as the balance sheet, there are many items; for example, a company has many assets, liabilities, and owner's equity. It is unlikely that we can clarify all these asset items, liability items, and owner's equity items at once.

We need to understand the most important issues. What are the most important items in the balance sheet? This can be viewed from the following two perspectives.
The first perspective:

The third question is about the company's investment.#

To assess a company's investment situation, we mainly look at changes in equity investments and changes in other receivables. We will discuss investment assets in detail later.
The fourth question is about the driving force. There are two parts:
The first part is long-term loans, which are the long-term borrowings from banks to the company.

The second part is the shareholders' input. Many companies may not have operational risks or financial risks, but they may have governance risks. Such companies are quite common. If the relationships among shareholders are not well managed, there may be good products and production capacity, but if the shareholders are not harmonious, it may also lead to poor overall financial conditions for the company. We will discuss this in detail later.

From this diagram, you can understand one thing: if you are the chairman, what aspects would you focus on?

The most important responsibility of the chairman is to mediate the relationships among shareholders, which is the driving force issue. Should we finance? If we need to finance, should we do it through long-term methods or by issuing new shares? How to set the price? These are all issues the chairman needs to consider.

The general manager should consider the production capacity issue, which is the potential issue of a company. The company may have good products, but as a general manager, I am more concerned about whether I will have good products next year, whether I will have good products the year after, and whether I will have good products three years later. This is the long-term production capacity issue of the company.

The vitality part is something the operations director needs to monitor. They need to keep an eye on whether the company's products are good, whether the short-term loans borrowed can support the company's operations, and whether the company owes money to suppliers or has accounts receivable that have not been collected. This is something an operations director needs to monitor daily.
The investment director, of course, needs to focus on the investment part. Thus, a balance sheet can reveal a company's strategic map through just a few key items.

A good company generally appears harmonious in every aspect. We will look at some companies later to see what a good company's balance sheet looks like and what a poor company's balance sheet looks like.

The second perspective:

The balance sheet can also be viewed from another perspective, based on the function of assets and the classification of liabilities. In this classification, we no longer differentiate between current assets, non-current assets, current liabilities, and non-current liabilities, but rather divide assets into operating assets and investment assets.

1. If a company claims to be a self-operating company, its operating assets must exceed its investment assets. The operating assets must include five major operating assets, and the amounts should not be small. The first is monetary funds; the second is commercial receivables, mainly accounts receivable and notes receivable; the third is inventory; the fourth is fixed assets; and the fifth is intangible assets. Any company claiming to be self-operating must have these five major operating assets.

For investment assets, we mainly look at its long-term equity investments, other receivables, and some prepaid accounts. What are prepaid accounts? Some parent companies prepay funds to their subsidiaries, allowing them to use them first. This is also a form of debt-like investment behavior.

2. Looking at liabilities, liabilities represent a form of credit, which can be divided into two types: bank credit and commercial credit.

Bank credit mainly includes short-term and long-term borrowings from banks.

To obtain bank credit, we often say we need to assess the company's "three qualities." First, how is the company's "reputation"? First, check if the general manager is reliable, if the chairman is reliable, and then assess whether the team is reliable, as well as whether the company has any past misconduct. These are all ways to evaluate a company's "reputation."

Second, how good are the company's products, and what is the gross profit margin? Furthermore, what about collateral? Nowadays, banks will ask if the company has collateral, and they will conduct due diligence to see if the collateral has been pledged elsewhere.

Commercial credit is also very important; it reflects a company's competitiveness in its upstream and downstream relationships. We can assess this through accounts payable, notes payable, and advance receipts. Simply put, if this company can owe money to upstream suppliers while downstream customers cannot owe money to the company, it means this company has strong competitiveness and bargaining power in its upstream and downstream relationships, indicating it is a relatively good company with strong product competitiveness.

How do the "balance sheet," "income statement," and "cash flow statement" connect?

These two diagrams both discuss the balance sheet. But we know a company has three statements; how does the balance sheet connect with the income statement and cash flow statement?

1. The first item to look at is "owner's equity." Owner's equity is what the shareholders have invested in the company, and the owner's equity can leverage a company's "assets." For example, if my company has 1 million yuan in shareholder investment and I borrow another 1 million yuan from the bank, it means I have 1 million yuan in shareholder investment, leveraging 2 million yuan in assets because I invested 1 million yuan and borrowed 1 million yuan from the bank, totaling 2 million yuan.
   The shareholders' investment leverages resources, and this "leverage" is what we call financial leverage.

Financial Leverage = Assets ÷ Owner's Equity. The greater our financial leverage, the greater our leveraging effect.

2. Once you have certain assets or resources, whether you can obtain a market is a significant issue. Many state-owned enterprises have abundant resources, but they struggle to open up the market.

Once there is a market and income, whether we can achieve profit and effectiveness is also a crucial issue.

From "owner's equity" to "profit" is a cyclical process where "owner's equity" leverages "assets," which in turn leverages "income," leading to "profit." However, for all owners, the most important consideration is how much profit I made from the 1 million yuan I invested. In other words, investors are most concerned about the return on equity, also known as ROE,
which is represented by the following formula:
Return on Equity = Profit ÷ Owner's Equity.
After a series of indicator conversions,

Return on Equity = Profit Margin × Asset Turnover Ratio × Financial Leverage.
This method is very famous; everyone who does financial analysis knows this method, called

DuPont Analysis.#

From the perspective of reading financial statements, we start from the balance sheet and then analyze the income statement and cash flow statement. These three statements can be connected through DuPont Analysis.

Everyone has two identities: CEO and COO. One is responsible for "selection," and the other is responsible for "operation."
Let's first talk about the CEO.

The most important job of a CEO is to make "choices," to "choose," or more radically, to "let go."

For a company, the most important resources are "team," "time," and "cash." "What to do," "how to do it," "when to attack," "when to retreat," and "which are more important" are all choices that a CEO makes daily.
For individuals, the resources available for the CEO to make "choices" and "allocations" vary at different stages of life.

In general, these resources include: time, long-term relationships, and cash flow.#

How to choose? An important criterion is to use a "long-term perspective" for measurement, whether it is "people" or "things." I also have two personal tips: choose things that have "invisible effects" and choose things that "do not show effects in the short term."

In the early stages of a career, most people do not have much cash to allocate. As a CEO, the most important resources at this time are time and work.
"What to do," "who to be with," and "how to allocate leisure time" are the most important "choices" for a CEO during this period.

If you are doing what you love, if what you do has social value, if you are in a fast-growing industry and company, and if your work environment and colleagues help you grow quickly, such choices are much more important than short-term salary levels.

Of course, what you do is important, and who you work with is also important. In youth, each person's values are still forming. At this time, who you work with and what you do often has a profound impact on your future.

I have to bring up what Buffett repeats in his annual letters to shareholders:

We only want to work with people we like and respect. This not only maximizes our chances of achieving good results but also brings us extraordinary joy.

By the way, in the book "Outsiders in Business," the author also believes that among all studies on Buffett and Munger, this point is the most overlooked. He says, "In choosing to maintain contact with the best people and businesses while avoiding unnecessary changes, there is a very compelling, intuitive logic. This is not only a path to outstanding economic returns but also a more balanced lifestyle. Among the many experiences they can teach, the energy brought by these long-term relationships may be the most valuable."

Let me give two examples of how to make choices using a "long-term perspective."

A few days ago, I was chatting with a friend about his previous experience with "part-time jobs." I do not agree with doing "part-time jobs" just for "money," and the reason behind this is: as your own CEO, you should realize that most "part-time jobs" are typical "linear" behaviors, lacking accumulation and nonlinear potential. Although there may be short-term gains, it is not a good choice in the long run.

Conversely, if you use your spare time to learn things you are interested in and enhance your skills, this knowledge and growth will make you better and ultimately be reflected in salary, bonuses, stocks, and other external rewards.

Additionally, as your own CEO, if you have investment experience and knowledge, you will have a deeper understanding of your value return cycle, allowing you to make better end-to-start thinking and decisions.

COO#

Now let's talk about the COO. Once your CEO identity has made the "choices," the COO's role is to steadfastly and focusedly "execute" and "manage" these "choices" well. I believe that as your own COO, the first thing is to be steadfast and focused.

Just like a company's strategy, whether it is effective often takes a long time, and a person's "choices" are similar. If a choice is made but cannot be fully committed and focused on the present during daily work, it is impossible to take the "chosen path" to the extreme, let alone discuss whether this choice is good or bad.

Today, I was chatting with a friend, and I mentioned this to him. First, use your CEO identity to make "choices," and then use your COO identity to be fully committed and 100% invested in executing this choice well.

Of course, the COO's focus is on "operations." I will still use investment to illustrate this.

Do you remember the ROE (Return on Equity) model we discussed earlier? If you don't remember.

Return on Equity (ROE) is a measure of the return on investment relative to shareholder equity, reflecting a company's ability to generate net profit from its asset net value. It is an important indicator of a company's profitability. The calculation method is to subtract preferred stock dividends and special income from net income and divide by shareholder equity. This ratio calculates the return on investment for common stockholders and is an important indicator of a listed company's profitability. A company's assets consist of two parts: one part is the shareholder's investment, i.e., owner's equity (the total of the shareholder's invested capital, corporate reserves, and retained earnings), and the other part is the funds borrowed and temporarily occupied by the enterprise. Proper use of financial leverage can improve the efficiency of fund utilization, while excessive borrowed funds can increase financial risk but generally can enhance profitability; insufficient borrowed funds can reduce fund utilization efficiency. Return on equity is an important financial indicator for measuring the efficiency of shareholder fund usage.

In simple terms,

1. Net Profit Margin = Net Profit ÷ Sales Revenue, indicating whether the products sold by the enterprise are profitable;
2. Asset Turnover Ratio = Sales Revenue ÷ Total Assets, indicating how many times the enterprise makes money;
3. Equity Multiplier = Total Assets ÷ Total Owner's Equity, reflecting the size of the company's leverage. I not only make money with my own investment but also borrow money from others to make money. So, how capable am I of leveraging external resources?

In the financial statements, it is displayed as follows:

In actual calculations, average net assets = (Beginning Net Assets + Ending Net Assets) / 2.

Net profit is easier to understand, Net Profit = Total Profit - Income Tax Expense.

While Total Profit = Operating Profit + Non-Operating Income - Non-Operating Expenses.

From the result data, the distinguishing standard between good and mediocre companies is long-term ROE (Return on Equity).
For each of us, the same applies. If we consider ourselves as individual enterprises, our "operating results" can also be presented as ROE. To manage our "enterprise" well, the ROE of your own "enterprise" should exceed the average level (other people).

Breaking it down: ROE consists of profit margin, turnover rate, and leverage ratio. What can you do as a COO? Improve turnover rate: you can enhance work efficiency and gradually take on more responsibilities and work;

Increase leverage ratio: you can help your team or build a personal brand to help your partners and others improve; Sam Altman once said that the best way to increase leverage is to "help others selflessly and without expecting anything in return." This reasoning may be a bit convoluted; you can slowly understand it yourself.

In this way, gradually, you will establish your competitive advantage. As a result of "operations," your ROE will significantly exceed that of others.

First Layer#

Breaking down ROE can quickly reveal a company's business model.
To create returns for shareholders, a company must enhance these three elements as much as possible, but due to industry differences and variations in the company's main business, this ultimately leads to differences in business models. Therefore, we can categorize A-share listed companies into three types of business models:

First Business Model: Companies with Pricing Power.#

Companies with this business model do not need to increase the equity multiplier through borrowing to operate the business and achieve sales targets, ultimately creating returns for shareholders. Such companies do not lack cash; accounts receivable are basically zero, and they have bargaining power over their upstream and downstream, often engaging in cash transactions.

Second Business Model: Efficiently Managed Companies.#

Companies with the second business model typically provide products or services that are widely needed, lacking scarcity, and mostly consist of daily necessities. Such companies do not need to borrow money frequently, and their cash flow is generally healthy.

Their concern is product homogeneity, and how to maximize efficiency through human management, leading to asset turnover rates that surpass those of their industry peers. Many companies fall into this category; they cannot increase ROE by raising prices because their products lack scarcity. Therefore, they can only enhance asset turnover to generate high returns for shareholders. The number of quality companies in this business model is significantly greater than in the first business model, making them worth tracking.

Third Business Model: Cyclical and Leveraged Companies.#

Companies with this business model typically belong to cyclical industries and use leverage to conduct their main business. For example, banks attract deposits by offering low-interest rates to depositors and then lend or invest these low-cost deposits at higher interest rates to achieve high returns. Thus, the funds obtained from depositors are liabilities, and this industry's debt ratio is generally very high, averaging around 90%. The higher the debt, the greater the profit.

Three different business models can be distinguished based on net profit margin, total asset turnover rate, and leverage ratio:
[ ] High profit, low turnover type
[ ] Low profit, high turnover type
[ ] Leverage type

Basic paths to wealth accumulation:

(1) Employment—Wealth accumulation subtraction#

The entry threshold for employment is not high, but it diminishes with time and opportunity. Successful individuals can turn simple addition into multiplication, even transforming it into an investment, typically through promotions or changes in job roles, such as middle management, CEO, or partner; while failures remain stuck in repetitive addition, and in harsh environments, may even face subtraction, such as severe inflation, layoffs, or changing industries.

(2) Independent Business—Wealth accumulation multiplication and division#

The entry threshold for independent business is not low; it requires not only a clever mind but also high emotional intelligence, exceptional willpower, and significant energy expenditure. Successful individuals may have impressive wealth, but they will also be physically and mentally exhausted, suffering from internal injuries.

(3) Investment—Wealth accumulation exponential multiplication and division#

Investment has the lowest entry threshold but permeates all aspects of life and reveals various facets of human nature. Life is full of investments; successful individuals not only accumulate wealth but also experience great mental and physical relief, leading to a relaxed and enjoyable life, steadily improving their life standards; while failures suffer loss of wealth, which is minor, but their mental and physical state is often completely shattered, living in a hellish existence with no hope of recovery.
Investment is a choice, a choice of your own life path; valuing investment is to value yourself.