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Definition
Joel Greenblatt defined Return on Capital differently in his book The Little Book That Still Beats the Market (Little Books. Big Profits) . He defines Return on Capital as follows:
Return on Capital = EBIT / (Net fixed Assets + Working Capital)
EBIT stands for Earnings Before Interest and Taxes. It is also called operating income. Fixed Assets are also known as non-current assets. They include the property, plant, and equipment that the firm needs in its operation. GuruFocus calculates working capital as: (Accounts Receivable + Inventory + Other Current Assets) - (Accounts Payable + Other Current Liabilities).
So Joel Greenblatts Return on Capital can be restated as:
EBIT / (Receivables + Inventory + Other Current Assets + PPE) - (Payables + Other Current Liabilities)
Formula
Return on Capital =
EBIT / (
Net fixed Assets +
Working Capital)
Explanation
The way Joel Greenblatt defines Return on Capital is a more accurate measure of how efficiently the company generates returns onthe capital actually invested in the business. EBIT is used instead of net income because the tax and interest payment may be affected by factors other than the core business operation. Intangible assets are not included in the calculation because they dont need to be replaced.
Joel Greenblatt uses his definition of Return on Capital and Earnings Yield (Joel Greenblatt) to rank companies.
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