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Written by
What CROIC is and how to use it Jae Jun
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Why you should think about using CROIC in your analysis of stocks Facebook (http://www.facebook.com/oldschoolvalue)
Twitter (https://twitter.com/#!/Jae_Jun)
One of the most lacking aspects to all the widely available screens such as Yahoo, MSN, Morningstar etc are detailed screen criterias.
They are all based on PE, PB, PS, ROE, BV and so on which don’t really help you nd better investments than the next person.
This is where the Old School Value screeners (https://www.oldschoolvalue.com/stock-screener.php) try to ll this void. I’ve been
working hard to come up with new value investing screen (https://www.oldschoolvalue.com/blog/stock-screener/) criterias and
formulas to nd the best strategies and opportunities.
One such strategy that I am very con dent in is the CROIC screener (https://www.oldschoolvalue.com/stock-screener/cash-return-
on-invested-capital-croic-stock-screen.php/).
CROIC – Cash Return on Invested Capital
Invested Capital = Total Equity + Total Liabilities – Current Liabilities – Excess Cash
The rst one was where a portfolio of 15 stocks were selected based on the current year and prior 2 years CROIC and ROIC
(https://www.oldschoolvalue.com/blog/valuation-methods/roe-croic-roic-formula/) being above 10%. Anything less than 10% didn’t
make the screen.
I always tend to try and nd companies with CROIC in the sweet spot which is usually above 10% as it indicates a strong executive
team and company.
Over a 9-10 year period, the result is outperformance by a huge margin for the CROIC strategy but looking at the screen in different
time frames, you wouldn’t have known.
Then it dawned on me that everyone looks for the above average companies. So I modi ed some more formulas and criterias to get
the next screen.
In the second screen, I removed the minimum CROIC and ROIC limit. This means that any company can make the screen, even if the
CROIC and ROIC is negative. But my reasoning is that regardless of what the actual CROIC and ROIC numbers are, if the company has
been increasing this metric for the past 3 years, the business is not only improving but management has done a good job of turning
the boat around.
In other words, the screen should result in successful turnarounds which are often explosive opportunities.
Before I explain further, click on the image below to get the best investment checklist that will help organize your thoughts and make
things easier for you.
Assuming you followed this strategy the only down period would have been from 2007-2010 but overall had you started in 2001, your
$100 would have grown to $850 by 2010 using the CROIC method and $385 using the ROIC method.
One thing is for sure on both accounts. CROIC is a much better indication of performance and better metric even in a screener.
I also added another criteria where FCF is increasing each of the past 3 years which also yield great results which I won’t display here
as the results are very similar to above.
I’ll be looking at FCF related screens and strategies in the next strategy review but rst, here are the companies that showed up in the
screen.
Disclosure
No holdings.
It is a stock grader, value screener, and valuation tools for the busy investor designed to help you pick stocks 4x faster.
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Awesome work! One question; how do you go about generating the actual screen? Did you write code that grabs thousands of stocks and their raw
data from a web database (MSN, Yahoo, etc), creates/populates elds normally not listed on screens (like CROIC), reduces the list somehow, and
displays them in a screen? The screens themselves don’t have a long list of names, so I assume there may be ltering going on. I’d like to replicate it
myself, just wanted to see if you could share your thought process
2. Eldinril says:
March 4, 2010 at 9:14 AM (https://www.oldschoolvalue.com/blog/investing-strategy/croic-roic-screen-strategy-backtest/#comment-4764)
I have noticed a couple of points in your work that have piqued my curiosity. If you don’t mind I would appreciate it if you would clarify these points
for me.
Invested Capital = Total Equity + Total Liabilities – Current Liabilities – Excess Cash
The rst part of the formula is “Total Equity + Total Liabilities”. By de nition, “Total Equity + Total Liabilities” equals Total Assets. Is there a reason why
you did not simplify this?
The next portion of the formula subtracts “Current Liabilities and Excess Cash”. Perhaps I am incorrect, but I have seen this also expressed as “non-
interest bearing current liabilities minus excess cash”. I am not certain which is preferable, but would appreciate hearing why including short-term
debt is preferable.
Finally, my explorations regarding the calculation of excess cash have encountered multiple approaches. From the total cash on the balance sheet,
some people simply subtract spontaneous liabilities, some subtract two percent of revenues, and some use the “current liabilities minus current
assets” method that you include. For some reason, I nd the rst two more intuitive than the latter. Have you considered using the other methods?
Best wishes,
Jim
3. JJ says:
March 4, 2010 at 3:21 PM (https://www.oldschoolvalue.com/blog/investing-strategy/croic-roic-screen-strategy-backtest/#comment-4770)
Great posts! I’d like to save several of your posts but I do a print preview and it runs to 10 pages, wondering if you might be able to add a print button
to put your posts in a more printable form. Thx.
The correct formula would be to use “non-interest bearing current liabilities minus excess cash” but I include all of current liabilities because this is
debt due within a 12 month period.
A company won’t borrow short term debt to generate more money. Instead, a business would borrow for a few years and then use that cash to
generate more capital.
For the excess cash method, I use it in the EPV calculation but the shortfall is that they are both assumptions. 2% of sales is only a rule of thumb and
a very rough one at that. I prefer to keep things safe and the excess cash formula I use suits me better than the other two.
@ JJ,
You can send the article to your email using the “+Share” button on the blue toolbar you can bring up by click on the bottom right blueish tab. Then
print from your email. Or I’ll put a print option very soon.
Great post ! Can I get the same e-mail that ‘Ozz’ got ?
I would argue that you have surpassed fwallstreet as a site. No offense to Joe (he’s on to bigger and better things) but posts are almost daily on this
site – YOU’RE A MACHINE !
Cheers,
Alex MacKinnon
6. Alan says:
March 4, 2010 at 4:48 PM (https://www.oldschoolvalue.com/blog/investing-strategy/croic-roic-screen-strategy-backtest/#comment-4775)
Jae, I am confused again. In your post, you say that DY and SPA both have increasing CROIC over the last 3 years, but when I use your spreadsheet
and download the values, the CROIC on both are decreasing. (I am looking at the value your spreadsheet gives for CROIC on the DCF valuation page,
under the “ef ciency and pro tability” heading.) If the source of information for the spreadsheet is different from the source you are using for your
screens, which is correct? If both are the same, why are there such striking differences in the values for CROIC?
Thanks,
AB
Thanks.
.-= Chroma´s last blog ..Lessons Learned from Mike Burry (http://chromainvesting.com/2010/03/04/lessons-learned-from-mike-
burry/#utm_source=feed&utm_medium=feed&utm_campaign=feed) =-.
8. psp627 says:
March 5, 2010 at 5:48 AM (https://www.oldschoolvalue.com/blog/investing-strategy/croic-roic-screen-strategy-backtest/#comment-4782)
Jae,
Excellent work. Could you provide more info on how you put the screens together? Also, how do you perform the backtests?
But I would lean more towards the spreadsheet for accuracy as I have full control the data used and I am con dent in those numbers.
Steve
That’s a very good idea. I’ll have to test out your suggested criteria. But depending on how depreciation is stated, couldn’t it overstate capex or
depreciation which means you could end up with a fair aggressive number without realizing?
@ Chuck,
Your formula is a very basic version of owner earnings so of course you can use it.
Thanks!
Is there a reason to rebalance every six months as opposed to a year and a day? I’m curious because of the bite short-term taxes would take out of
such returns, even if good. Though if the strategy does worse on a year and a day rebalancing rather than a six month rebalancing, then that’s also
worth noting.
Thanks!
I dont think 6 months is that bad. After all it’s about 60 trades a year max which is less activity than most active investors.
I trade more than this considering I don’t trade often.
Also keep in mind that these screens are for the idea purposes. To let you see how certain strategies work. I don’t advocate mechanical investing.
Just a great way to nd ideas and capitalize on the best ones.
i thought of it mainly because many of these screens show great long-term returns but use much shorter strategies in terms of holding…very few
people could hold after seeing a 75-80% drop in their portfolio and then imagine how fun it would be to rebalance at the bottom…maybe there is a
way to screen for long-term holding of these companies
21. Owen says:
May 9, 2010 at 6:05 AM (https://www.oldschoolvalue.com/blog/investing-strategy/croic-roic-screen-strategy-backtest/#comment-5410)
Jae, when more than 15 stocks meet the screening criteria, how do you determine which 15 stocks to include in the portfolio? I guess what I’m really
asking is if I do the same test, I may choose a different set of 15 stocks, and get totally different results. Correct?
I don’t think that addresses the survivorship bias issue. If your backtest only includes companies that are currently active and doesn’t include
companies that were delisted (not necessarily bankrupt but most likely) then you might be overstating returns. The point of survivorship bias is that
you’re testing a strategy on a set of companies that in 2010 we know survived, unless your database includes delisted companies. So there’s an
element of “seeing into the future” which biases the test.
I wouldn’t ignore this as the number of delisted companies in the past 10 years is quite large and most of them are the micro and small caps that
your screens buy.
Great blog you have. I have a query that I thought you might be able to help. What should we do if CROIC is extremely high? (40% to 50%). The
company in question is a telecom company in a highly regulated industry (I live in Singapore – we have only three major telecoms, 2 big 1 small) so
there is a really strong economic moat. However, if I were to use the given growth rate, wouldn’t the IV of the company calculated be extremely high?
In your opinion, should there be a moderation of CROIC above a certain level?
Thanks!
This is a very interesting post. I’ve been using Greenblatt’s “magic formula” for approximately 3 years and it has outperformed the S&P by ~ 7.5% per
anum. I’m intrigued by the approach you’ve taken here. I have a couple of questions: (1) what computer package do you use to perform backtesting,
(2) how would one (me) go about backtesting a strategy, and (3) given that you’re testing 15 stock portfolios, what do you do when > 15 stocks pass
the screen (take the highest 15 as measured by FCF yield?)? Again, I thought this was a very interesting post. I enjoy reading your website. Best of
luck and happy new year!
im just using customized spreadsheets, my database and server, scripts and some other stuff.
And yes I just rank them according to some metrics. I can’t remember which one for this test though..
Do you mean recommend a stock from the CROIC list? My best rec would be to just go through a few that catches your eye. That way, you’ll learn
about those companies and begin to nd what you are looking for.
I noticed a couple of things on the CROIC spreadsheet and hope you can comment on: Alot of the stocks seem to have recently reached an all time
low in price. It’s as if they’re at the bottom of their charts. Is that indicative of stocks that show up on this screener? If so, why is that?
Also…on the table of stocks for this screener, There appears to be 20 – 30 stocks or so. However, in your description of how you ran the initial
screening tests, you say you chose no more than 15 stocks. So, why is there more than 15 stocks on the CROIC spreadsheet?
Thanks – Rob
This screen is designed to nd companies that were struggling but have started to turn the ship around. Since CROIC is increasing, management and
the company went from losing money to making money, thus the type of companies that show up will likely be at their 52wk low stock prices.
I only used 15 stocks for the backtest because it is realistic of what someone would be able to replicate and purchase. But the table has a max of 30
stocks to provide more options in case some junk stocks also shows up.
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