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

• • •

Missing some Tweet in this thread? You can try to force a refresh

Keep Current with Finsense Gurukul

Finsense Gurukul Profile picture

Stay in touch and get notified when new unrolls are available from this author!

Read all threads

This Thread may be Removed Anytime!


Twitter may remove this content at anytime! Save it as PDF for later use!

Try unrolling a thread yourself!

how to unroll video
  1. Follow @ThreadReaderApp to mention us!

  2. From a Twitter thread mention us with a keyword "unroll"
@threadreaderapp unroll

Practice here first or read more on our help page!

More from @FinsenseG

12 Oct
Thread: EBITDA Margins

EBITDA: Earnings Before Interest, Taxes, Depreciation & Amortization is a measure of companies operating profit as a percentage of its revenue. Image
EBITDA margins can be used to do peer comparison within the industry. It depicts how much operating cash is generated by the company for every rupee in revenues.
A company with improving EBITDA margins should be looked upon favorably as it shows the efficiencies are being achieved through effective cost-cutting or improved capabilities.
Read 5 tweets
9 Oct
Thread: Debt Service Coverage Ratio (DSCR)

One way to judge the strength of a company is to check its ability to pay current outside obligations (interest+principal) from the income generated during the year. DSCR is an important ratio used by banks and financial institutions
Let's understand DSCR in depth.
Debt Service Coverage Ratio is calculated by dividing Net Operating Income (alternatively EBITDA) by Total Debt service costs. Debt service costs include interest to be paid on all existing loans along with the principal repayments during the year.
Let's take an example: A Ltd. has EBITDA of Rs. 200 crores during the current year. It has to repay Rs. 50 crores to lenders (Rs. 45 crores as principal and Rs. 5 crores as interest).
DSCR = Rs. 200 crores/Rs. 50 crores i.e. 4 Times.
Read 5 tweets
8 Oct
Thread: Working Capital Cycle (Operating Cycle)

The book definition of WCC refers to number of days required for the entire process of business from the purchase of raw material to the realization from the customers.
Let us, deep-dive, into the process and understand how we can apply this in the analysis of a company.
Eg: A Footwear Manufacturer:

As the image above shows, first, the company procures raw material (rubber) and starts processing it to derive the final product that is Footwear.
The process involved is known as Work-in-progress and the final product is called Finished Goods. Once the raw material is converted into finished goods, they are sold to customers which concludes the Sales part of the cycle.
Read 7 tweets
7 Aug
Thread: Bonus issue and it's effect on stock prices

Bonus as the word suggest refers to something that is received without consideration or price. A company may reward it's shareholders in form of cash payouts (dividends) or stock payouts (bonus issue).
Bonus issue is carried out by company having huge amount of free reserves that can be capitalized. Eg: A company has been making profits and accumulated free reserves. These reserves can be used to issue bonus shares which converts them into share capital.
Let us say a company has Rs. 1,00,000 of share capital and Rs. 1,00,000 in reserves and surplus. Company has 10,000 shares outstanding of face value Rs. 10 each.
If the company decides to issue a bonus of 1:1 (1 share in bonus for 1 share held),
Read 6 tweets
4 Aug
Thread: Depreciation: Why is it important?

A business requires assets to operate and generate profits. These assets like Plant & Machinery, Equipment, Furniture etc are used to run the business.
When a business purchases assets, they are used for longer duration. Eg: If a company purchase a machinery, It may be used in business for 10-15 years. Since the usability of asset is more than 1 year, the same cannot be treated as expense in 1 year and shown in P&L Statement.
But this machinery will become obsolete after 10-15 years, So how to provide impact of such obsolence?
By charging a certain amount to Profit & Loss statement every year in form of Depreciation.
Read 5 tweets
3 Aug
Thread: Cash Flow Gimmick!

As we all know the Cash Flow Statement (CFS) shows the movement of cash in and from the company in a current period. However we need to have some eye for detail to check if there is anything unusual going on with the business.
Let us take an example of a company that is growing sales at a decent pace. usually it should have growing cash flows too at around same pace. However, What could go wrong?
So if a company focuses too much on growing it's topline (sales) in order to report growth in numbers, there are chances that it might not be able to efficiently collect money from it's receivables (debtors). i.e. It might have to offer extended credit to customers
Read 8 tweets

Did Thread Reader help you today?

Support us! We are indie developers!

This site is made by just two indie developers on a laptop doing marketing, support and development! Read more about the story.

Become a Premium Member ($3/month or $30/year) and get exclusive features!

Become Premium

Too expensive? Make a small donation by buying us coffee ($5) or help with server cost ($10)

Donate via Paypal Become our Patreon

Thank you for your support!

Follow Us on Twitter!