Five 'Little Book' Stocks That Beat The Market

Take a look at five little stocks: COH, MHP, CF, FWLT, DISH.

Good Business: High Return on Tangible Capital

Return on capital is similar, but not identical, to the return on assets rate that Buffett and other gurus like Peter Lynch use. Rather than using a company's reported earnings, as is done when calculating ROA, however, Greenblatt uses earnings before interest and taxes (EBIT), so that debt payments and taxes don't obscure how well the firm's actual operating business is doing. (Given the impact overleveraging has had on companies lately, this makes more sense than ever.) Greenblatt also doesn't divide the earnings portion of the equation by total assets, as is done when calculating ROA. Instead, he divides it by "tangible capital employed," which is equal to net working capital plus net fixed assets. "The idea here," he writes, "was to figure out how much capital is actually needed to conduct the company's business."

Cheap Price: High Earnings Yield

He again uses EBIT rather than earnings, and he divides EBIT not by price but by "enterprise value." Enterprise value includes not only the price of the company's shares, but also the amount of debt it uses to generate earnings. Greenblatt is really measuring how much of a return you could expect if you bought the whole business, including all its debt. Looking at a simple E/P ratio can be misleading, he wisely notes, because it doesn't take that debt into account.

Read more:
http://www.forbes.com/2009/03/31/joel-greenblatt-dish-personal-finance-g...