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 screenerdatabase). For example in the EURO zone we have +/- 2000 companies available in our list. The formula then assigns a rank to those companies, from 1 to 2000, based on their return of capital (ROIC).The company with the highest ROIC gets rank 1, the company with the lowest gets rank 2000.
Next, the formula follows the same procedure, but this time the ranking is done using earning Yield(EY). The company with the highest yield is assigned a rank of 1,and the company with the lowest earning yield receives a rank of 2000.
Finally,the formula just combines the rankings. The formula is looking for the companies that have the best combination of both two factors. So a company that is ranked 232nd best in return on capital and 153rd highest in EY,gets a better combined ranking than a company that is ranked 1st in ROIC but only 1150th bast in earning Yield. Because the first company has a better combined rank of 385 (232+153=385) than the second company has (1+1150 =1151)
How are EY and ROIC defined ?
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Return on Capital= EBIT / (Net Working Capital + Net Fixed Assets)
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Earnings Yield= EBIT / Enterprise Value.
The return on invested capital measures how efficiently the assets of a company have been used to generate income. The higher this ratio, the better.
A good company is not always a good investment. The value of a good company can be so high, that it is a bad investment idea. Most obvious, or most used, to measure this, is the P/E ratio. If we reverse this ratio we get the ratio in terms of percentage between the operational profit and market capitalisation. A share with P/E of 20 has earning yield of 5%. Greenblatt goes a step further. He does not compare the operational profit only with the market capitalisation, but with the total value of the company (Enterprise Value) . The total value of the company is the market capitalisation plus financial debts minus available cash
Stocks are skipped if they are not in an industry to which the formula applies. (Banks and insurance companies are skipped from the screener!)
Excess Cash is determined. If Total Current Assets are greater than 2 * Total Current Liabilities, then Excess Cash is determined to be the lesser of Cash And Short Term Investments or Total Current Assets - 2 * Total Current Liabilities, otherwise it is zero,
EBIT is calculated as the trailing twelve months operating profit if available (if not then EBIT equals last year operating income)
Net Working Capital is calculated as Total Current Assets - Excess Cash - Total Current Liabilities if Total Current Assets exceeds Total Current Liabilities, otherwise it is zero
Net Fixed Assets is calculated as Total Assets - Total Current Assets - Total Intangible assets,
Enterprise Value is calculated as Market Cap + Long-Term Debt + Minority Interest + Preferred Stock - Excess Cash. If the returned value for Enterprise value is negative, then a default value of 1 € is used.
Important! For some companies we are missing some data in our Datastream-source. These companies get rank 99999 by default. This does not mean that they are bad companies. It is only that we don't have ( temporary ) all necessary data.
What additional information is available in the list? (Complementary ratios)
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Graham Current Assets Ratio = [ (Current assets - Total debt - provisions - minority interests) / Market Value ]
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Surplus Cash/MV = Surplus (Excess Cash) / Market Value
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EV / 5Y AVG EBIT = Enterprise Value / 5 Year average EBIT