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Our own interpretation of "Value Investing"(ERN5)

Finding stocks with a “considerable margin of safety” isn’t a stand alone feature. When it comes down to investing in a stock, the investment needs to have a considerable earning power as well. So we thought of a screening method (simular to the Greenblatt's Magic Formula ) that would cover the issue of cheapness and earning power as well. Instead of the 2-parameter model used by Greenblatt (EY & ROIC) we will apply 4 parameters; but we still searching for a combination of cheapness and a profitable earning power.

We selected the following 4 variables:

• Earning Yield
  (EBIT / Enterprise Value)
  How much is a business earning compared to the entreprise value ( purchase price) of the company.
• ROIC Last 12 months (Return on invested capital)
  How much capital is needed to conduct its business earnings factor. The return on invested capital measure gives a sense of how well a company is using its money to generate returns
• NCAV (Benjamin Graham Net current asset value)
  How much “margin of safety” is there on the purchased price factor compared to the company's net current assets ?
• 5 year trailing ROIC
  This indicates the development of earnings over a 5 year trailing period.A company could had have an exceptional good year (or last 12 months). But did the company obtained also good returns on its investments over a longer period? ( for example over the last 5 year business cycle?)

How is the formula calculated ?

The formula start with the list of all the companies in a monetary zone (we have 3 zones nl EURO, UK or USA available in our screener database). For example in the EURO zone we have +/- 3500 companies available in our list.

Each variable( EY/ROIC/NCAV and 5Y trailing ROIC) is calculated and ranked separately(best score gets 1st place, worst score gets highest). Finally,the formula just combines the 4 rankings. The formula is looking for the companies that have the best combination of all four factors. So the different rankings are then summed up and re-ranked following the same procedure.

Example

• Company A has following scores (12/125/40/600) sum 777
• Company B has following scores (1/1/5/1500) sum 1507
Company A will have a better final ranking than B because the total score is better.

This, in the end will give us a more weighed measure for all 4 factors. This thesis will be back tested as well.