Hi! Do you know that a fund manager in America gave a 40% annual return to his investors for 20 consecutive years?
It is unbelievable, right? We are talking about investors, hedge fund managers, author, and professor Joel Greenblatt.
You may not have heard their name before, but it is believed that their years use age-old investment techniques to beat the market even today.
Investing Techniques Or A Magic Formula? magic formula!
Greenblatt popularized his technique as a magic formula and apply it, over the years beating the markets by a good margin.
In today's video, we will talk about this magic formula and know which are the top 5 stocks in India according to the formula.
But before that let's understand Greenblatt and his investment philosophy.
Greenblatt explains his investment strategies and the magic formula he has written books such as:
You can be a stock market genius
The Little Book That Beats the Market
Big secret for the small investor,
Common Sense: The Investor's Guide to Equality, Opportunity, and Growth, etc.
Greenblatt believes in value investing.
Let us see what the value investment is after the decision of Greenblatt.
So as you have seen, Value Investing is buying all the companies at a discount.
But how to find a good company?
And not only that, anyone can buy shares of companies that make good profits,
but even among those companies making good profits, choosing such companies where investors to make very good money is an art!
And using that art, Greenblatt has very systematically created a magic formula.
According to Greenblatt's formula, it is important to focus on mainly 2 major factors for investing in a stock.
One is the quality of the company and the other is the value of the company.
For quality, Greenblatt says we should make a list of the most profitable companies. And for profitability, they ask to use ROCE.
ROCE- Return on Capital Employed is a financial ratio that tells how efficiently a company is using its capital and how much return it making.
A company that has better capital utilization efficiency generally outperforms its competitors and is the leader in its segment.
Because doing consistently high ROCE is not an easy task.
If you just sort companies with more than ₹ 1000 crore market cap based on ROCE, then surprisingly, you will see the top companies of India.
To calculate ROCE, we divide EBIT means earning before interest and tax by the total capital employed.
the formula is like this-
EBIT means Earning before interest and tax mean in easy language, how much profit a company has been working before paying tax and interest expense.
That is, we find out how much profit the company is able to generate from its core operations.
And the total capital employed includes the equity and debt of the company.
That's why it's a good metric to judge companies that operate with high debt.
Generally, the higher the ROCE, the better it is for a company as it tells ​​how efficiently the company is able to utilize its equity or overall capital.
Now that was the first part of Greenblatt's formula, which covers the profitability aspect.
From the first part, we got the list of the best companies, but with the help of the 2nd part of the formula, we will know which companies to invest in.
According to Greenblatt, only companies that are relatively cheap can help in wealth creation.
Now generally everyone uses the P/E ratio for value. But Greenblatt uses earnings yield, which is a proxy of P/E itself.
To calculate this, we divide a company's operating profit by its enterprise value.
To calculate enterprise value, you need to subtract the company's cash from the company's market capitalization and total debt.
Here Enterprise Value has been used because it can be taken into account of the total market value of the company.
Market cap as a company's total equity value, along with debt, gives us a measure of the company's overall value.
And the market cap already contains the company's share price as well.
As Greenblatt pointed out, with enterprise value, we bring companies that have debt and companies that don't have debt at the same level.
So, from the total earnings yield i.e. (EBIT/Enterprise value), we get to know how much profit the company is making over its total market value.
Now the higher the earnings yield of any company, the more affordable that company can be considered.
So Greenblatt says that we should make another list that will have the companies that have the highest earnings.
By combining the list from both ratios, they assign a rank to the companies, i.e. such companies which are good in both factors will be at the top.
One more thing, Greenblatt performs the exercise by taking the value of a minimum market cap.
Greenblatt recommends that the magic formula is to hold the top 20 to 30 stocks for at least 1 year and repeat the exercise every year,
so that only stocks that are consistent performers are on the list.
Now you are thinking that doing this exercise can be a bit difficult for retail investors like us.
But don't worry, we are! We've got the top 5 stocks for you to apply, the magic formula of Greenblatt.
We have made a simplified model by making some tweaks to this formula and then selected the top 5 companies that fit this model.
We have given equal weightage to both the key parameters i.e. ROCE and Earnings Yield.
And we've created a formula for the Greenblatt ratio.
Apart from this, we have selected only those companies whose market cap is more than ₹ 5000 crores.
After applying these filters, we have selected the 5 companies that have the highest Greenblatt ratio.
And now you can see those five companies on your screen.
The top 5 companies are General Insurance Corporation of India, Nestle India, LIC, Procter & Gamble Hygiene & Health Care, and Colgate-Palmolive (India) Ltd.
As you can see, General Insurance Corporation has the highest Greenblatt Ratio of 87.42.
The company's ROCE is 11.81% and the 1-year return is -14.94%.
At number 5 is Colgate-Palmolive (India) Limited with a Greenblatt Ratio of 46.04.
Colgate's ROCE is 92.04%, 1 Year Return is -3.57%, and 5 Year Return CAGR is 8.55%.
Similarly, you can see the Greenblatt Ratio, Debt to Equity, P/E Ratio, ROE, ROCE, and Returns of all other companies.
But keep one thing in mind, you should not invest directly in stocks.
We create these educational videos so you can understand expertly apply different metrics to stock filters.
But before deciding to invest in any stock, you should also do the second level of research.
That's all for today. If you liked this video and got to learn something new, then do like it and share it with your friends.
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