Operating Income (EBIT)
- Cost of Goods Sold
- Selling, General, & Admin. Expense
(SGA) - Research & Development
- Depreciation, Depletion & Amortization
Operating Income or EBIT is linked to Return on Capital for both regular definition and Joel Greenblatts definition.
Return on Capital (ROC) = (EBIT - Adjusted Taxes) / (Book Value of Debt + Book Value of Equity - Cash)
Joel Greenblatts definition of Return on Capital:
Return on Capital = EBIT / (Net fixed Assets + Working Capital)
It is also linked to Joel Greenblatts definition of Earnings Yield:
Earnings Yield = Earnings before Interest & Taxes / Enterprise Value.
EBIT is also linked to Operating Margin:
Operating Margin = Operating Income (EBIT) / Total Revenue.
Compared with a companys EBITDA margin, Operating Margin can be manipulated by adjusting the rate of depreciation, depletion and amortization (DDA).
If a company is facing competition, its Operating Margin may decline. Often the Operating Margin declines well before the companys revenue or even profit decline. Therefore, Operating Margin is a very important indicator of whether the company is facing problems.
For instance, by 2012, Nokia (NOK)s problems were well known and its stock had lost more than 90% of its market value since 2007. But Nokias Operating Margin had already been in decline since 2002, although its earnings per share were still rising. Investors who paid attention to Operating Margin would have avoided this huge loss. The same can be said for Research-in-Motion (RIMM).
Therefore, Operating Margin is a very important screening filter for GuruFocus. GuruFocuss Buffett-Munger screener
requires that the profit margin is either consistent or expanding. The Model Portfolio of the Buffett-Munger screener has outperformed the market every year since inception in 2009.
Return on Capital
, Earnings Yield
, Operating Margin