Greenblatt proposes to do this as follows: if a company is the tenth highest performer related to EBIT/VE (10) and third highest related to ROIC (3) then we give it a score of 10+3=13. Keep only the companies with the highest results.įinally, once these two calculations are done, rank the selected companies according to the highest returns (EBIT/VE) and the best return on investment (ROIC). Again, the calculation is relatively simple: ROIC = EBIT / (net assets + working capital). To do this, simply calculate the EBIT/Enterprise Value and keep only the companies with the highest results.Īnother rule is that one should only buy companies with returns on invested capital (ROIC) that are higher than the average for their sector. In addition, select companies with pre-tax earnings yields above the average for their sector. Famous ADRs include Alibaba, Tencent or Shopify. In other words, these are foreign companies listed in the US. ADRs are foreign shares listed on the US market via a certificate issued by a US bank. Among these categories we can count water, gas, electricity or energy suppliers in general.ĪDRs (American Depositary Receipts) are not eligible for selection.
banks, holding companies and investment funds are excluded. We therefore advise you to select only companies with a minimum market capitalization of $1 billion.įinancial stocks, i.e. This amount, set almost 20 years ago, is no longer really relevant. A few adjustments are necessary before implementing this formula.įirst, the market capitalization of the selected companies must be at least $50 million. It is not enough to simply apply these two filters to all companies. By comparing the ROIC of different companies, it is possible to identify those that generate the highest return on invested capital.
ROIC (Return on Invested Capital) is a measure of return on invested capital, either in terms of benchmarking the economic performance of several companies or in terms of value creation by a company. Greenblatt uses EBIT (Earnings Before Interest and Taxes) as opposed to net income because it puts companies with different debt levels and tax rates on an equal footing when comparing their returns. So the higher the multiple, the better for the investor. EBIT/EV and ROIC.ĮBIT/EV is supposed to be a measure of return on earnings. The final goal is to find undervalued stocks with high returns on the capital they invest.īut first, let's go back to the two ratios mentioned above. Now we've piqued your curiosity, let's see how this academic managed to generate a net return of 30% per year via his hedge fund Gotham Capital from 1985 to 1994.Īs mentioned in the introduction, this incredible performance is supposed to come from a formula made up of two ratios, allowing companies to be selected according to profitability and return criteria.
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