Cross-section between high earnings yields and high return on capital
The earnings yield tells us how good fast the company is generating value.
The return on capital tells us how good the company is at creating value (profits) using what its got in the coffers.
- Establish a minimum market capitalization (usually greater than $50 million).
- Exclude utility and financial stocks.
- Exclude foreign companies (American Depositary Receipts).
- Determine company's earnings yield = EBIT / enterprise value.
- Determine company's return on capital = EBIT / (net fixed assets + working capital).
- Rank all companies above chosen market capitalization by highest earnings yield and highest return on capital (ranked as percentages).
- Invest in 20–30 highest ranked companies, accumulating 2–3 positions per month over a 12-month period.
- Re-balance portfolio once per year, selling losers one week before the year-mark and winners one week after the year mark.
- Continue over a long-term (5–10+ year) period.
Earnings Yield = (Earnings Before Interest & Taxes + Depreciation – CapEx) / Enterprise Value (Market Value + Debt – Cash)
ROC = \frac{\textrm{Net Operating Profit} - \textrm{Adjusted Taxes}}{\textrm{BV of Debt} + \textrm{BV of Equity} - \textrm{Cash}}