This is a simple book where I will summarize everything in one article.
Key points:
- Criteria 1: High ROC = EBIT / (Net Working Capital + Net Fixed Assets)
- Using EBIT allows us to compare operating earnings of different companies without distortions arising from differences in tax rates and debt.
- Net Working Capital (NWC) and Net Fixed Assets is used as we want to figure out how much capital is actually needed to conduct the company's biz. NWC is used as business have to fund receivables and inventory, company must also fund purchase of Fixed Assets.
- Criteria 2: High Earnings Yield = EBIT / Enterprise Value
- Enterprise Value (EV) = Market value of equity (Include preferred) + net interest bearing debt
- EV was used as it takes into account both price paid for equity and debt financing.
- Ensures that we hold at least 20-30 stocks at one time
- Each stock was held for 1 year.
- For stocks showing loss from initial buy, sell a few days before 1 year holding period is up.
- For stocks with gain, sell a day or two after 1 year period is up.
- Probably don't want to buy all 30 stocks at once
- Adding 5-7 stocks every few months until we reach 20-30 stocks
Book suggested 2 options to use the strategy:
Option 1:
Step 1: Go to website MagicFormulaInvesting.com
Step 2: Follow instructions for choosing company. (>50 mil should be fine)
Step 3: Follow instructions to obtain a list of top-ranked company
Step 4: Buy 5-6 top-ranked companies. Invest only 20-33% of money intended to invest during the first year
Step 5: Repeat Step 4 every 2-3 mth until you have invested all the money. After 9-10 months, there should be around 20-30 stocks
Step 6: Sell each stock after holding for 1 year. Use the proceeds from the sale and additional investment money to replace the sold companies with an equal no of new selection (Step 4)
Step 7: Continue this process for many years
Option 2:
Step 1: Use your own screener with the following screening instructions
- Use ROA as screening criterion. ROA > 25%
- From the resulting screen, screen for stocks with lowest P/E
- Eliminate utilities, financial, foreign company
- Eliminate very low P/E (<5)
- Eliminate company with announced earnings in the last week
Step 2: Follow steps 4-8 from Option1 instructions
That's all for this book. I believe I have summarized all the main points of this book. Feel free to browse through a copy of the book if interested.
