One of the ways I intuitively infer if a company continues to grow well and potentially has some kind of scale economics is if the Gross Revenue is growing faster than the growth in the operating expenses side over any given period.
Seems obvious to me.
This is one the topics discussed most recently by Geoff Gannon on the Focused Compounding podcast.
And I believe this is a specific way of looking at what Buffett is getting at when he says that you know when you have an economic franchise when you can raise prices. Here’s the quote:
“the single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business…”Warren Buffett
This ties back to the fact that, if the company can raise prices (seemingly every year above inflation just like Buffett’s See’s Candies), continue to keep the same level of sales, that only equates to rising revenue and likely gross revenue. Of course the best business would be to have the rate of growth in the gross revenue be well north of the rate of growth in the operating expenses, but even if it were nominal and at the same rate, it potentially means that it keeps earning the same rate of return (I think).
Lastly and this is also something the Mr Gannon from Focused Compounding has said in other podcast episodes, that the further up you go the Income Statement, you’re evaluating the business economics and the lower you go, you’re evaluating the capabilities of the management.
All the more important to be looking at the Revenue and the Gross Margins in any given year and especially over longer periods of time to see if there is erosion there or it maintains it (within some nominal standard deviation).
Said another way and is best summarized by Mr. Buffett himself: “The extraordinary business does not require good management.”