Thread by @FinsenseG

Thread: The Magic Formula by Joel Greenblatt

The author of the book "The Little Book that Still Beats The Market" Mr. Joel Greenblatt shared a formula to assist small investors to pick winning stocks. It combines two factors: Return on Capital and Earnings Yield. Dive in.

ROC is a ratio of Pre-tax operating profits (EBIT) to Net Tangible assets (net fixed assets + net working capital).

EBIT: Earnings before interests and taxes
Net fixed assets: Gross fixed assets - Depreciation
Net working capital: Current assets - Current liabilities

This ratio tells us how much capital is actually required by the company and how efficiently they are converting the investments into profits.

Earnings Yield is a ratio of EBIT to Enterprise Value
Enterprise Value: Market Capitalization + Debt - Cash

This ratio tells us how much money is expected to be made for every rupee invested in the share.

Let's try to find some companies to invest using this formula

Application of the formula:
1) Find ROC and EY of the companies
2) Assign ranks to companies based on ROC and EY. Higher ROC and EY will get Rank 1.
3) Calculate combined rank & sort companies by preference to lowest ranks.
4) Invest in companies with the lowest combined ranks.

Eg: Step 1 & 2

Step 3 & 4

Conclusion: If we were to invest in any three companies, then those would be B Ltd., D Ltd. & C Ltd. respectively.

by @RJGyanchandani