Today I’m going to introduce you to Warren Buffett’s secrets to identifying and investing in company stocks that made him super rich! Today, we are analyzing Co-Diagnostics, Ticker CODX. Yes, Finviz lists Co-Diagnostics’ earnings per share this year as up by 510%, with a gross margin of 83%. But, does this stock stack-up to a Warren Buffett type analysis?
This series will take you through a Warren Buffett type discovery of stocks, to discover if they have the potential to make you super rich!
Warren Buffett, worth $97 Billion, is the most successful investor in America, and the fifth richest man in America, behind Jeff Bezos, Elon Musk, Bill Gates and Mark Zuckerberg. Today I’m going to share Warren Buffett’s stock evaluation techniques. I picked this ticker CODX because, it is a potential investment that I am analyzing for my own portfolio.
For years, I worked with company CFOs and financial consulting teams helping fortune 500 companies to determine where they were making money, and during this time learned more about analyzing financial statements. Later, when I learned of the book, “Warren Buffett and the Interpretation of Financial Statements,” by Mary Buffett and David Clark, I realized that this book shared the secrets I had been missing, how to identify companies with a long-term, durable competitive advantage. These investments that can make you super rich over the long-term! The book teaches how to identify those stocks that over the years, have the potential to deliver greater and bigger profits. For your convenience, I have provided a link to this Buffett book, “Warren Buffett and the Interpretation of Financial Statements,” in the description below.
This is a detailed video, which could be consumed in chunks, so I added chapters in the description below the video. Here, you can pick up where you left off, or review the key portions.
To give you a brief introduction to Warren Buffet’s techniques, he originally learned about value investing from Benjamin Graham, who seeking to invest in a stock for only two or three years. But then, Warren discovered the wealth-creating ability of a company that possessed a long-term competitive advantage. He discovered that the longer you held these types of companies, the richer you became. All he had to do was to buy the company/stock at a fair price, not particularly a bargain basement price. Mary Buffet, Warren Buffett’s daughter-in-law, captured the investor’s techniques, along with David Clark, who was an investing student of Warren Buffet and kept notebooks filled with Warren’s investing wisdom. The book served as a short, easy-to-use guide to evaluating a prospective stock’s financial statements while leveraging Warren’s set of tools.
Warren Buffet first advises you to understand, the best you can, what a company does, and its potential competitors. Studying five or even 10 years of a company’s financial statements will also provide insight into trends, whether in a positive or negative direction. So keep in mind that this approach cannot be successfully applied to OTC or pink sheet companies that provide little financial reporting, and that lack the oversight of a company that is listed on a major exchange.
But we can use Buffet’s approach to a Company like Co-Diagnostics that is a micro-cap company listed on the NASDAQ exchange, and is currently in the $10 to $11 dollar range. So, let’s dig into Co-Diagnostics details to learn if this stock has the potential to make an investor super rich!
This is Lynn, and welcome to this first stock analysis. But first, remember I am not a financial advisor so this is for entertainment only! But, It’d be great if you could give this video a thumbs-up in return for all my hard work analyzing the CODX ticker, which took me many days to complete!
So, let’s get into it!
First, we need to identify companies with a competitive advantage in an industry or region.
Co-Diagnostics offers the Co-Diagnostics SARS-CoV-2 direct saliva testing, kit. This is an extraction-free test versus for example a blood-draw test. The patient’s saliva can be self-supplied, then heated and combining with PCR Reagents then running the reaction to test.
Then CODX has more recently developed a LOGIX Smart SARS-CoV-2 DS real-time test. This test targets two genes within the Covid-19 virus. Co-Diagnostics believe they can identify any Covid-19 strain. They offer PCR testing results in less than 30-minutes through an at home self-tests. For the test, the patient spits into a tube, and uses a swab to place it in a tube. The patient puts the tube into a 4 ½ by 4 ½ cube machine which a smart phone activates. Within thirty minutes the patient receives a test result sent to this phone. For Co-Diagnostics, the Covid-19 virus was the catalyst for creating this type of test over the past year. And, you will soon see that versions of this test to-date have enabled Co-Diagnostics big bump in positive financial results.
Co-Diagnosics is based in the U.S. but in March of 2020 announced that their joint manufacturing venture in India, CoSara Dignostics, had become the first Indian company to be licensed to manufacture a COVID-19 PCR test. This was a big deal, and has provided a great boost to Co-Diagnostics revenues, as you will soon see.
So now that we know a little about Co-Diagnostics, let’s next use Warren Buffet’s approach to financial statements’ interpretation to determine if Co-Diagnostics may have a long-term or durable competitive advantage. If it qualifies as a company that could make us super rich?
Over the past year, CODX has had a 52-week price range of $7 to $20.69. Like many micro-cap companies, Co-Diagnostics’ stock was affected by the overall pullback in price that you can see in the Russell 2000’s stock chart. But can we expect this price slide to turn around in the future?
Buffett recommends that when identifying an exceptional company with a durable competitive advantage, we search for an exceptional company with:
- A unique product or service
- Warren Buffet unique product examples were: Coca-Cola, Pepsi, Hersey, Procter & Gamble, and Altria.
- Unique Services are provided by companies such as: Moody’s Corp, H&R Block, American Express and Wells Fargo.
Or, we can search for a company that is:
- A low-cost buyer/seller of a product or service that has a consistent public need.
- Low-cost providers include: Wal-Mart and Costco, where their big volume makes up for a decrease in margins
This is where we can find a company with the potential to make you super rich, that may have a durability competitive advantage. So far, Co-Diagnostics appears to have a somewhat unique product and service.
Warren Buffet found that some manufacturers such as Coca-Cola, are truly exceptional, as Coke has been selling the same product for 122 years. This is a fantastic business because they don’t need to spend millions of dollars on research and design or R&D.
But, how can we find out more about Co-Diagnostics, and if this company has the potential to make us super rich? We are now going to follow Warren Buffett’s analysis outlined in the book.
Warren Buffet dives into the financial statements, where he looks for consistency in:
- Gross margins
- A low amount of debt
- Consistent earnings, and a
- Consistent growth in earnings
Buffett also searches Income Statements for:
- Excellent profit margins,
- Great returns on equity, and,
- A consistent direction of earnings
A company’s BALANCE SHEET will reveal:
- How much money is in the bank, and
- How much is owed
Then, subtracting the two and we get the company’s net worth.
(Remember that Company balance sheets are usually generated for the:
End of the fiscal year and end of a quarter)
The company’s CASH FLOW STATEMENT will reveal:
- Money being spent on capital improvements
- Bond and stock repurchases
I usually use Yahoo finance statements at YahooFinance.com, as and then do a quick doublecheck against a company’s filings at sec.report to ensure that the yahoo numbers are updated and complete.
A company’s INCOME STATEMENTS include:
- Revenue
- Expenses, and
- Profit/Loss
The goal is to dive into this data to uncover businesses with a:
- Durable competitive advantage, versus a
- Mediocre businesses
Then we want to buy businesses with a competitive advantage at a fair, or better, price
The Outcome is to meet Buffett’s goal to make us super rich, if the company meets Buffett’s requirements, is held for the long-term, and maintains the advantage.
How to identify a business with a durable competitive advantage from its financial statements?
Let’s apply Warren Buffett’s techniques to Co-Diagnostics’ Income statement. Remember that revenue equals the amount of money coming in the door during the financial statement’s yearly or quarterly period. In looking at Co-Diagnostics’ income statements since 2017, we see a steady growth of revenues each year from $7,662,000 to $74,554,000 in 2021, and trailing 12-month revenues of $96,347,000. This shows great positive progress in this area. (Remember that I’m adding three zeros to all the numbers you are seeing here on the screen as the numbers are listed in thousands).
Next, we determine the Profit/loss for Co-Diagnostics by: deducting the company’s expenses from the total revenues.
The company’s total expenses were $4.5 Million in 2017 growing to $32.8 Million in 2020.
This means the company’s net profits in 2020 were obtained by taking the $74.5 Million of Revenues and subtracting the $32.8 Million of expenses, to realize $41.6 Million of Net Profits
Remember Buffett teaches also that controlling expenses are key to enabling a company to make higher profits, and that this means controlling company expenses and spending less! (I’ve certainly found this also to be true also in my personal life.)
First to find out more if this is a company that can make us super rich, we need to locate Co-Diagnostics’ Cost of Goods, or Cost of Revenue if the company is providing a service rather than product.
We find this by looking at the Cost of Goods or Services subtracted from the total revenue = the Gross Profit or Loss.
For the CODX ticker, we look at the Cost of Revenue which was $16,591,000 in 2020.
Then we calculate the gross profit margin:
By taking the Gross Profit, divided by the Total Revenues, to obtain the Gross Profit Margin
FOR CODX we can see that their gross profit has been growing steadily each year since 2017. In 2020 the gross profit was: $57.9 million, divided by total revenues of: $74.5 Million = 77.7% which I rounded to 78% – this is excellent!
Companies with great long-term economics have consistently higher gross profit margins, and a competitive Advantage,
For example, Warren Buffet described Coca-Cola’s average gross profit margin as 60%+
Moody’s (the Bond rating company’s) gross profit margin was 73%+
Microsoft’s was 79%, and
Apple’s was 33% at the time the book was written.
These gross profit margins were compared to companies in highly competitive industries such as:
Unites Airlines with a gross profit margin of 14%,
General Motors’ with 21%, and
Goodyear Tire’s with 20%.
In reviewing all the numbers, so far Co-Diagnostics looks like a winner with a 78% gross margin. This is a good first step to discovering if CODX has the potential to make you super rich!
Before we move on, if you haven’t yet, please give this video a thumbs-up, and subscribe for more videos from this series!
Next, Buffet described killers of high gross margins, when companies have high operating expenses such as:
- High R&D, or research and design costs
- High Sales & Administration Costs
- High interest costs
- High interest costs on debts
These operating expenses are totaled as Operating Profit/Loss (Expenses) Co-Diagnostics Operating expenses have grown each year to $16,268,000 in 2020.
Co-Diagnostics’ expenses were $16,268,000 in 2020 and their gross profit was: $57,961,000. Approximately 28% of the gross profits were expenses, which was a huge improvement over their numbers in 2017. Fortunately, the company’s gross profits are increasing steadily as expenses become a smaller ratio.
Buffett explains that keeping consistent expenses in the above areas are very important. Companies without a durable competitive advantage suffer from intense competition and a wild variation in their SG&A costs, as a percentage of gross profit.
Buffet’s book described the example of General Motors over a 5-year period going from spending 28% to 83% of gross profits on SG&A costs. Ford over the same period was spending 80% to 780% of gross profits on SG&A costs which meant that Ford was losing money like crazy.
When sales and revenues fall, but SG&A costs remain, this eats into the company’s profits.
So let’s check our example company! Clearly CODX’ SG&A costs were massive with $3.5 Million in 2017 compared to a mere gross profit of $7,360, and with very poor ratios all the way through 2019. The ratio for 2020 was a great improvement with 22% SG&A costs as a percentage of the gross profit of $57.9 million. These numbers clearly don’t reflect the excellent multi-year low ratios that Buffett requires, but seem to be going in the right direction, for now. The recent trailing 12-months numbers reflected SG&A costs as a 26% ratio to the $80.4 Million in gross profits. Which is reasonable.
A durable advantage, competitive company has low SG&A costs, per Buffett, who explained that a ratio under 30% is fantastic! So, with Co-Diagnostics; 26% SG&A to gross profits for the trailing twelve months, this is a good improvement – but the company is missing the mark of multi-year ability to keep ratios low.
Buffett explains that there can be some good companies that could have SG&A expenses in the 30% – 80% range. But a ratio of 100% or more means a company is in a highly competitive environment.
The Buffett book shared that Intel had issues, that despite a low ratio of SG&A expenses to gross profits, because of high R&D costs, the company had its economics reduced to merely average. Yet if Intel stopped doing R&D, the company would be obsolete within ten years or less!
So as a rule, Buffett steers clear of companies with consistently high SGA expenses.
Buffett also warns that an investor has to check if a competitive advantage may be due to a company’s expiring patent. Technological advancement can also be replaced. Also remember that new technology requires the expensive creation of new sales programs and administrative costs.
In the book, Buffet provided the example of Merck that had to spend 29% of the company’s gross profit on R&D and 49% of gross profit on SG&A. Combined they consumed 78% of Merck’s gross profit – pretty scary!
Moody’s, the bond rating company, per Buffett’s book, had no R&D expenses, and on average spent only 25% of gross profits on SG&A expenses. Coca-Cola had no R&D and spent only 59% of gross profit on SG&A Costs.
CODX’ $1 million in R&D costs during 2017 were enormous compared to a gross profit of $7,360, and again the ratios continued to be terrible until 2020. The current trailing twelve months reflects R&D costs of $8.9 million as 11% of gross profits. Again, an investment in Co-Diagnostics would mean an investor is taking a bet that these improved results could continue. This makes this investment in this area, questionable regarding if CODX could make you super rich!
But first, before we continue, please remember to share this video with others, so that they can learn these techniques to becoming super rich also!
Next we need to check Co-Diagnostics’ Depreciation. Buffett explains that machinery and buildings wear out over time, and are reflected as depreciation on an income statement. The yearly depreciation amount is the portion of the asset that has been used in the company’s business activities over that year, or quarterly period.
Companies with a competitive advantage have lower depreciation costs as a percentage of gross profit, than companies that have intense competition.
Per Buffett, Coca-Cola’s depreciation was running about 6% of gross profits, Procter & Gamble at 8%, bus General Motors with lots of tough competition realized a depreciation of 22% to 57%.
CODX’ Depreciation of $231,000 for the current trailing 12-months is 2.8% of the $80.4 Million Gross profits. But again, here, the ratios for previous years from 2017 to 2019 were very poor with a 64% ratio in 2019!
Next let look at ways to analyze a company’s debt load through interest expense to find out if Co-Diagnostics is a company that has the potential to make you super rich! Buffett explains in the book that companies with high interest payments relative to operating income are:
- In a fiercely competitive industry. Buffett gave the example that Procter & Gamble, with low competition, held a mere 8% of operating income as interest costs. But, Goodyear, in a competitive, capital-intensive tire business had to pay on average 49% of operating income in interest payments.
- Alternately, there are some companies, that although they have excellent business economics have been saddled with huge amounts acquired debt when the company was bought in a leveraged buyout.
Warren Buffett also searches for companies with a durable competitive advantage that have interest payouts of less than 15% of their operating income. But this varies by industry as Wells Fargo Bank pays our approximately 30% of operating income in interest payments. And, this bank is an AAA rating from Standard & Poor’s.
The investment banking business on average makes interest payments of approximately 70%.
Warren Buffett looks for the company with the lowest ratio of interest payments to operating income, for a competitive advantage.
Let’s check if Co-Diagnostics is suffering from debt and high interest payments as a ratio to operating income. The company’s operating income was negative for 2017 through 2019, so obviously the ratios would be very poor. But, with the great improvement in operating income for 2020, and the trailing 12-months, Co-Diagnostics appears to have no interest payments at the present, which is great news!
Buffet also notes that gain/loss sale assets are a one-time event that should be ignored related to a competitive advantage. And, I didn’t see an entry for these items on the CODX’ income statement.
Buffet always compares a company’s income before tax, after all expenses have been deducted, but before income tax has been subtracted.
American corporations have to pay taxes on their income, which at the time the book was written was approximately 35% of a company’s income. In 2021, the average for combined Federal and State taxes is about 25.8% (because some states have no corporate taxes, and the other states range up to 11.5%) This tax is reflected as ‘income tax paid’. Buffet warns that companies can fudge on their numbers, so he recommends to double-check and take the pre-tax operating income, then deducted the current 25.8% from it. If this 25.8% doesn’t equal the amount the company reported as income taxes paid – start asking questions!
Now let’s check Co-Diagnostics’ pre-tax operating income for 2020, (before 2021 the company was losing money so the 25.8% income tax would not apply). IN 2020, CODX’ Operating income was $41.6 Million, and they show their tax provision as $90.5 thousand, which isn’t anywhere close to the $10+ Million that would equal 25.8%.
So, as Buffett recommends, let’s do some digging.
I found that a Note 9 in the financial statements, that you see here, reflecting that CODX deferred $547,224 of income tax that was not included in the annual report summary numbers. This is still much lower than what it should be!
Then I found a second Note 9 for taxes-1 in the annual statement, which you see here, that is listed Federal, State, and “other” tax benefits for a total of $9.8 million. This gets us to the $10 Million+ income tax number that I was looking for, so the 2020 Operating income of $41.6 Million appears to be correct!
Buffett’s book also stresses that a company’s Net earnings should show an historical upward trend, and that here, consistency is key! To indicate a durability of competitive advantage, lacking a smooth upward trend is okay. We look for an historical average. You can see here that Co-Diagnostics EBIT (which here is the same a net income) numbers reflect a gradually decreasing loss for 2017 through 2019. Finally in 2020, the company realized a Net Income of $42.5 Million. I do believe that Buffett would want to see positive numbers for all these years, so here investing in Co-Diagnostics would again be a gamble that the new, positive tend can continue. We are still unsure whether this is a company that could make you, at some point, super rich!
Buffett stresses that company’s share repurchase programs can throw off the historical per-share earnings. But, I didn’t see any evidence of “treasury shares” or a stock repurchase program in Co-Diagnostics’ financial statements. Buffett emphasizes the importance of a company’s stock repurchase program to increase the value per share for current shareholders. But, since Co-Diagnostics has no treasury shares, we will skip this part.
A company shares repurchase program can increase the per-share earnings view, though, even though it hasn’t actually increased. Therefore, Buffet recommends that we look at net earnings versus the per-share earnings for a more accurate view. Co-Diagnostics would only have a favorable ratio in 2020. Here the net earnings, or EBIT of $42.5 Million, are 57% of the 2020 $74.5 Million revenues. This will be fantastic if CODX can show a continued trend! I’d love to hear your comments about Warren Buffett’s investing strategies, CODX, or a any other stocks you are liking right now.