We made it to the final installment of our Graham vs. Greenblatt series. Throughout the series we examined each of the ratios that Greenblatt recommended in his book The Little Book that Beats the Market. The final posting will look at how Greenblatt draws the ratios together and bring this all back around, so lets get into it.
What is it?
Greenblatt says:
It then assigns a rank to those companies, from 1 to 3,500, based on their return on capital. The company whose business had the highest return on capital would be assigned a rank of 1, and the company with the lowest return on capital (probably a company actually losing money) would receive a rank of 3,500…
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In our last post we looked at Greenblatt’s use of Return on Capital as a means of identifying quality companies that know how to turn a small investment into a substantial return. In this posting we will look at his next criteria earnings yield.
What is it?
EBIT
enterprise value
What does it tell us?
EBIT is defined as Earning before Interest and Tax, as we discussed in the last posting that works out to the raw income flowing into the company.
Enterprise Value is defined as market capitalization – cash and cash equivalents + preferred stock + debt
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 Greenblatt in his book The Little Book that Beats the Market advocated a simple method for attaining substantial stock returns. In this series we are looking at the particulars of this investing theory to both understand why he advocated the elements of this theory and what Benjamin Graham would have thought of the approach that Greenblatt was advocating. The next part in this series looks at Return on Capital or ROC.
What is it?
Earnings Before Interest and Tax (EBIT)
Net Working Capital + Net Fixed Assets
EBIT is a raw calculation of the regular company income excluding the income from irregular or non-reoccurring activities.
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 Joel Greenblatt is a modern value investor, his approach as we outlined in our previous post was to find value companies like Graham, but he also wanted a company that has potential for the future. The first set of criteria looks very similar to Graham.
What is it?
- Establish a minimum market capitalization (greater than $50 million is recommended).
- Exclude utility and financial stocks and any foreign companies (Non US).
What does it tell us?
Market capitalization = Number of outstanding stock * Current Price of stock
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 Graham passed away in September 21, 1976 well before Joel Greenblatt graduated from Wharton in 1979 but a linkage between the two men’s investment theories is not difficult to find. Greenblatt during his time at Wharton went to great lengths to study the value approach that Graham had devised (there are stories that Greenblatt entered vast amounts of stock data by hand into a mainframe and then ran tests on it using Graham’s system). He saw the benefit that could be returned from purchasing companies that were inexpensive.
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