Joel greenbelt magic formula

This is simple formula which can be replicated in any stock market, its premise is very simple buy his growth business at lowest price.

Every month i will update the stocks as seen through this formula. The formula is very simple and it works like this

Step by step instructions

Hold minimum 20-30 stocks
each stock was to be held for one year ( For losses sell a few days before 1 year .For gainers sell a few days after 1 year.

adding 5 to 7 stocks to portfolio every few months until we reach 20 or 30 stocks

Once the stocks reach one year holding mark ,we will replace only 5-7 stocks which have been hold for one year.

How to find the stocks

Use ROA as screening criteria set the minimum ROA at 25% (this will take the place of return on capital from the magic formula)                      Eliminate all utilities and financial stocks        Eliminate all foreign companies                      Eliminate very low P/E ratios e.g. 5 or less     company announced earning last week(minimise the incidence of incorrect or untimely data)
from resulting group of High ROA stocks Screen for stocks with the lowest P/E( this will take place of earning yield
3)Buy 5 to 7 ,top ranked companies
4) Repeat  step 3 every 2 or 3 months until you have invested all the money you have chosen to allocate
5) Sell each stock after holding for one year, Sell the winners few days after one year and losers few days before the year for tax purposes.

Lately Mr Greenblat has done some minor changes in calculating the return on capital and earning yield

Return on capital =EBIT/(Net working capital +Net fixed assets)

basically ratio of pre tax earning to capital employed.

EBIT was used in place of reported earnings because companies operate at different levels of tax and debt.Using EBIT allows us to view and compare the operating earning of different companies without distortion arising from difference in tax rates and debt.

Net working capital +Net fixed fixed assets (tangible capital employed) is used in place of total assets or equity.The idea is to figure out how much capital is actually needed to conduct the company’s business.In addition to working capital requirement, fixed assets is also required to run business.The depreciated net cost of this fixed asset was added to the net working capital requirements already calculated to arrive at an estimate for tangible capital employed.

2.Earning Yield

EBIT/Enterprise value (market value of Equity + net interest bearing debt)

It correctly represents how much a business earns relative to the purchase price of the business.
Enterprise value is used because it takes into account both the price paid for equity stake in business as well as the debt financing used by the company.

This allows us to put  companies with different level of debt and different tax rates on an equal footing when comparing earning yield.