Greenblatt's Little Book That Beats The Market Message Board

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Strategies & Market Trends : Greenblatt's Little Book That Beats The Market

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To: jsabelko who wrote (157)	4/6/2008 1:23:04 PM
From: bruwin	Read Replies (1) of 218

Hi there joby. The person who showed me much of what goes on in a company’s Financial Statements stated the following in one of his books on company analysis ... "The Capital Employed by a company is the total of :- Share Capital & Reserves + Long Term Loans + Deferred Taxation .... (1) and the Employment of that Capital is the total of :- Fixed Assets + Current Assets – Current Liabilities .... (2)" Needless to say, (1) must always equal (2). This is basically what you also referred to, and he’s never found it necessary to emphasize "Goodwill" or "Intangibles". I’m sure he would have if he thought them relevant. But he wrote the above in the 1980’s when Goodwill was treated differently than today. However, I speak to him on a regular basis, so I’ll get his opinion on the latest treatment of Goodwill. Maybe your suggestion of a "modified Capital Employed" will have merit for those companies that reflect Goodwill and Intangibles on their Balance Sheet. As far as I’m aware, Goodwill is the excess amount a company has paid for another company over and above its Net Tangible Assets. In the "old days" this excessive amount was "written off", or amortized, over a period of time in its Income Statement. At the present time, Goodwill is regarded as an Asset and is tested annually for Impairment which could result in some write-off on the Balance Sheet. If we look at equation (1) above it’s difficult to see how Goodwill could affect any of those 4 items. "Share Capital" is what the company obtained from the public when it sold them its shares. "Reserves" are generally the algebraic accumulation of the Bottom Line of a company’s Income Statement. Seeing as there is no longer Amortization, how does Goodwill affect the Income Statement ? "Long Term Loans" are self explanatory. "Deferred Taxation" is what the company puts aside for any future tax liabilities. No doubt in Greenblatt’s form of analysis, a lot of emphasis would be placed on the EBIT/Cap.Employed ratio, as there is very little else to consider, apart from the EBIT/Enterprise Value ratio. But if one considers several other critical ratios in one’s analysis then one gets a broader perspective of a company’s ability to produce shareholder value. Speaking for myself, I currently just use equation (1) for "Capital Employed".

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