Joel Greenblatt was interviewed on Maria Bartiromo’s show on CNBC last night. He stated the main principles of his strategy are to look for companies with high Returns on Capital and good Earnings Yield (The upside down value of P/E ratio).
He has a separate web site called www.magicformulainvesting.com where one can put in your own information regarding the size of the company you’re looking for and it will screen for that info.
Now my reason for writing this is because the man who taught me about investing on the stock market, and how to identify Quality companies, was a Dr.Karl Posel D.Sc. Ph.D. I’ve commented about him and his investing strategy in the other Forum, "Value Investing" (moderated by Paul Senior).
Dr.Posel brought Greenblatt’s book to my attention because of an article about it in our local newspaper and its reference to Return on Capital (I’ve since ordered my own copy from Amazon).
The fact of the matter is that Dr.Posel’s Investment Strategy requires that a company must satisfy 12 "Laws", 8 of them are Financial Ratios obtained from within its Financial Statements. We give each of these ratios a percentage target that the company must meet or exceed. One of these critical ratios is Pre-Tax Profit/Capital Employed. We prefer Pre-tax profit because it doesn’t include the possible once-off tax credit etc.. a company may receive, as well as Extraordinary Items that may follow Pre-Tax profit on the Income Statement. This ratio is similar to what Greenblatt uses, although I suspect he probably uses Net Income/Capital Employed (I’ll find that out when his book arrives !).
Once we get our "short list", we then also do what Greenblatt does and identify those companies that are currently "cheap" or undervalued (we don't use Earnings Yield). From that ‘shorter’ list, we then determine which of these companies are most likely to give the greatest percentage price increase in the next 6 months. Only those few companies are then purchased.
So the main principle behind our Strategy is the fact that we would only consider a company’s stock for purchase if it satisfied ALL 12 "LAWS", was currently ‘cheap’ and was most likely to give an above average future percentage price increase.
Joel Greenblatt stated that his strategy works sometimes, but not always. I suspect the reason for that is the fact that one or two critical financial ratios don’t always tell you the FULL STORY about a company’s financial state. There are other areas within the financial statements that also need to be interrogated.
It’s only when EVERYTHING "gels" that one can confidently invest, because a 'losing' company would not be able to reflect and satisfy certain criteria from within its financial statements as does a 'winner'.
I noticed that certain contributors here seemed very "fixed" in their outlook regarding stock market investing, and the relevant value of their own, or other, approaches in this regard. Personally, I believe that an "open mind" in most areas of life leads to ongoing personal discovery and accumulation of knowledge.
I would also like to respectfully suggest that an understanding and application of the science of mathematics should form a VERY IMPORTANT component of one's stock market investing strategy.
For those who may be interested, you can contact me at bruwin90@yahoo.com. |
