5 ms·
Your idea of "earnings per dollar of market cap" is essentially the same as "earnings yield", or inverse of the P/E ratio, which is indeed much more meaningful
by aaavl2821 8y ago
Your idea of "earnings per dollar of market cap" is essentially the same as "earnings yield", or inverse of the P/E ratio, which is indeed much more meaningful than EPS
Earnings yield is a measure of how expensive a unit of earnings is, and can be compared across companies as a heuristic for "cheapness".
Another metric is free cash flow yield: free cash flow / market cap. Using operating free cash or operating profit like EBITDA gets you the cost of operating cash flow excluding non-operating stuff like interest, taxes and non cash depreciation expense
You can also use enterprise value as the denominator (market cap plus debt less cash) to capture the full picture of a company's capitalization
By buying groups of stocks based on these metrics, rather than just index funds, you can blend aspects of passive and active investing. This is called "smart beta" and is an interesting emerging strategy
A good primer is "the little book that beats the market". The strategy is to buy "cheap and good" stocks and just hold them. Cheap is defined by high EBIT / EV (lots of earning power per unit of capital) and good by high ROIC (the business can turn money into more money). So you filter by these two metrics, then buy the top x companies, buying one stock / month over a year to mitigate timing risk, and hold
- melling 8y agoI believe that you need to buy about 20-30 of these companies then hold each for about a year, to get long-term capital gains, then reevaluate. Greenblatt claims that statistically this will work. The Magic Formula: https://en.m.wikipedia.org/wiki/Magic_formula_investing https://en.m.wikipedia.org/wiki/Magic_formula_investing Has anyone tried it?
- aaavl2821 8y agoI haven't tried it though I find it intellectually appealing. Actually implementing it requires some config (do you want to include all industries, or exclude some like finance as greenblatt suggests? What range of market caps will you consider? US only or emerging markets? Do you short companies on the bottom of the list or do long only?) I just haven't spent the time thinking through those things...
- MR4D 8y agoThere's a good article on more current results here: https://seekingalpha.com/article/2944796-beating-the-little-book-that-beats-the-market https://seekingalpha.com/article/2944796-beating-the-little-... Short version is that the alpha has shrunk considerably.
- melling 8y agoThe Acquirer’s Multiple is another similar formula: http://acquirersmultiple.com http://acquirersmultiple.com
- ISL 8y agoOne must be careful to avoid a "value trap". Occasionally, a company is inexpensive for a reason, and that reason can be hard to discern at a glance.
- __blockcipher__ 8y agoThat is of course true. However, I've noticed many seem to justify any stock price being low as the market already pricing in all the information. However when you look at AAPL's valuation 1-2 years ago, shares went down to a low of around $90, which was only like 6-7 FCF or so (it's a little complicated cause you had to subtract apple's cash hoards but also multiply by some uncertainty factor < 1 that represented the probability that they would be able to bring the money back). Meanwhile you have companies like MSFT, etc which while growing at a fast rate, are far, far more expensive on a FCF yield basis. Ultimately - and this is pretty obvious but worth stating - you have to come up with your own valuation for a given company when making investment decisions.
- aaavl2821 8y agoThat's a risk, but ROIC is supposed to somewhat counter that by ensuring the company is creating earnings from its invested capital (i.e. It's a "good" company). Can also only include large cap stocks and diversify to remove some of this risk