{"id":272,"date":"2021-05-03T12:06:04","date_gmt":"2021-05-03T06:36:04","guid":{"rendered":"https:\/\/www.smevalueadvisors.com\/blog\/?p=272"},"modified":"2021-05-24T12:56:15","modified_gmt":"2021-05-24T07:26:15","slug":"the-little-book-that-beats-the-market-book-summary","status":"publish","type":"post","link":"https:\/\/www.smevalueadvisors.com\/blog\/index.php\/the-little-book-that-beats-the-market-book-summary\/","title":{"rendered":"The Little Book That Beats The Market: Book Summary"},"content":{"rendered":"\n
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Almost everyone has heard about the recipe for making money<\/a> in the stock market \u2013 buy great businesses and at a great price. However, no one ever specified \u201chow\u201d. There are many more questions including what do you mean by a great business, how do you know a business\u2019 worth, and finally, how do we know whether a business is available at a bargain price. This is exactly where this book provides simple solutions. The following 3 steps can help you in investing in stocks for the long term.<\/p>\n\n\n\n

Step 1: Identifying great businesses<\/strong> <\/h4>\n\n\n\n

Great businesses essentially have some differentiation or competitive advantage<\/a> – unique products and services, distribution network, technological superiority, customers loyalty, efficient operations etc. But, identifying businesses with these advantages from the web of lakhs of businesses is undoubtedly an uphill task. <\/p>\n\n\n\n

Joel consolidated these parameters into a simple numerical number – Return on Capital Employed (ROCE)<\/strong>. The concept is quite simple – if a business is flourishing<\/a>, it should be making a lot of money<\/a> (This argument would not work for utilities, which are unique businesses but their output pricing is generally regulated) and that is what ROCE computes \u2013 the amount of money a business makes on each dollar of invested capital. <\/p>\n\n\n\n

ROCE is computed as Earnings Before Interest and Taxes (EBIT)\/(Net Working Capital + Net Tangible assets). EBIT compares firms by avoiding the impact of debt level (capital structuring decision of management) and differentiation in taxation<\/a>. Also, EBIT being the earnings available to both the equity and debt providers is the right measure of earning for this formula. <\/p>\n\n\n\n

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Step 2: Is Mr Market offering that business at a great price?<\/strong> <\/strong><\/h4>\n\n\n\n

Great price here infers low price. After determining the ROCE, Joel recommends another parameter – Earning yield (reverse of well known and widely used parameter – P\/E ratio). However, here, earnings are taken as EBIT (not net profits or earning per share) and the price is taken as Enterprise Value (EV) – Market Price of Equity + Debt. <\/p>\n\n\n\n

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The thought behind using EV is important because when you purchase shares of a business, equity is not a sufficient determinant parameter. You need to assume debt in the business. Hence, the true price of the business is EV and not just equity market value (market capitalization).<\/p>\n\n\n\n

The latest EBIT, market capitalization and available balance sheet data are used for these computations. <\/p>\n\n\n\n

Step 3: Investing and Divesting<\/strong><\/h4>\n\n\n\n

Having identified two parameters – measures of great businesses and great prices, Joel provides a step-by-step procedure for investing\/disinvesting as follows: <\/p>\n\n\n\n