Theme: Buy high ROC stocks with high earnings yield (low P/E).
On average, companies that have a high ROC have a durable competitive advantage that other companies don’t have. There will be some companies that attract new competition, thus lowering their ROC, but this is not the case for all companies.
- Earnings Yield EBIT/Enterprise Value
- Enterprise Value is Market value of Equity and preferred shares + net interest bearing debt
- ROC is EBIT/(Net working capital + Net Fixed Assets)
- Under performance will happen with this strategy, but that ultimately washes out the weak hands and enables this to beat the market over the long run. If a strategy worked all the time, every time, it would disappear.
- Managers might use this for some time but the nature of their environment is to beat the market. Their clients begin to leave and their jobs become in jeopardy from the lack of out performance so they abandon it.
- For non-experts, you would want to include 20-30 stocks in your portfolio. If you are capable to forecast future earnings well enough, try to narrow it down to 5-8 concentrated stocks, all from your Magic Formula list.
- Over the long run, Mr. Market gets it right.
If using a screener online, use the following filters:
- ROA 25% or higher
- Lowest P/E (above 5)
- No Financial/Utility stocks
- No ADR
- Market Price: most recent closing price
- Earnings: Use TTM earnings
- Balance sheet: most recent quarter
Related Book Notes
