Greenblatt's Formula For Spanish IBEX35

by: Gasebu Private Investor

IBEX35 is the most widely followed index in the Spanish stock market.

I wanted to check the condition of IBEX35 companies with the help of Greenglatt's Magic Formula.

Finally, I compare the three most appreciated companies with the ones that are cheaper according to the formula and try to figure out what investors might be thinking.

The Magic Formula and its methodology

Mr. Greenblatt has become known among other things by his magic formula, in principle a useful tool to easily set up an investment portfolio in a consistent and recurring way.

It is a fairly simple system based on a double ranking made from two ratios. The rank of each company under both ratios is added to determine the formula value for that company.

The logic behind it, is that the highest position in the combined ranking (the lowest value of the formula) is given for cheaper companies that will eventually provide the best return for the investor. It is very well explained on chapter 4 of "The manual of ideas", probably better, certainly more briefly, than in the inventor’s own book.

The first ranking is based on the return on capital employed, or ROCE:

ROCE=NOPAT / Capital Employed

ROCE = NOP x (1-t) / (Equity Book Value + Net Financial Debt)

where NOP is Net Operative Income and NOPAT is NOP after taxes

The second one is based on a very similar ratio which is the enterprise value yield:

EV Yield = NOPAT / Enterprise Value

EV Yield = NOP x (1-t) / (Market Capitalization + Net Financial Debt)

As you can see, the difference between both ratios is only in the denominator.

While in the ROCE we compute the return over the equity of the company (plus net financial debt) in the EV Yield we take in account the actual value of that equity in the market (plus net financial debt).

Both ratios use the net operative profit after taxes (NOPAT) as their numerator which is a measure of what the business makes before taking in account leverage or any other non-operative results.

A brief note on methodology:

  • Capital employed is calculated in different ways. I have used one that is relatively simple, since it only uses three data inputs: equity book value, financial debt and cash and equivalents. A more accurate way is to add all asset balance sheet lines that have to do with the business (inventory and PPE for example) and deduct all liability lines that have to do with the business (as payables for example). That route requires deeper review of each line and therefore it's more appropriate for individual stock valuation.
  • I have used the figures provided by the Financial Times database as inputs for the formula. I have adjusted the NOP figure by one-offs registered like that on the operative income according to the info provided by FT. I have not made adjustments or deeper analysis of those figures.
  • I use a single 25% tax rate (the standard tax rate in Spain) for all the companies, except for the two REITS in the index which have a 0% tax rate.
  • Since we’re on January all of the info is based on 2017 accounts. The market cap data is based on prices as of 14th of January 2019.
  • On the ranking I have not included financial, nor REIT, companies since they are hard to compare using this formula.

Having said that, the figures for all the companies in the ranking are shown in Table1:

Table 1. IBEX35 ex-financials constituents

Greenblatt's formula for Ibex35

And the resulting “magic formula” ratios and rank positions are shown in Table2:

Table2. Formula outcomes for IBEX35

The average ROCE for all the non-financial constituents is 6.2% while the EV Yield is 5% since companies tend to be traded above their equity book values.

Companies with higher ROCE and EV Yield are at the top of the list. Those are the companies that at the same time have businesses that are more profitable and that are cheaper (yield more) in the market. The formula obviously tries to strike a fairly simple balance, an equal weight between the company's yield and the investor yield for a given NOPAT relative to the rest of companies in the market.

The three Beauties

The three companies that are at the bottom of the least are Cellnex (CLNXF - CLNX in FT), focused in wireless communications, Siemens Gamesa (GCTAF - SGRE in FT), the wind turbine industrial company, and Ferrovial (FRRVF - FER in FT), the construction and airport operator company.

If we go a bit deeper in the performance and multiples of these three companies, we can see on Table 3 that:

  1. For the last four years, their revenues have increased substantially. GCTAF increased revenues at 27% CGAR, CLNXF at 13% and FRRVF at 11%. For an economy that has grown in the 2.5-3.5% range it’s a remarkable growth performance.
  2. In contrast to the growth in revenues, the growth these companies have achieved in their NOP (“NOP G” column) is quite poor. Only CLNXF has increased its NOP in these last 4 years, while GCTAF and FRRVF have in fact decreased their NOP in this period. This is problematic since it could indicate that investors might be misled by the growth in revenues as and indicative for growth in operative earnings which is what really matters in the long term.
  3. Obviously, if revenues grow and NOP stalls or decreases then the operative margin (“NOP Margin column”) cannot do much but decrease. The NOP Margin is a reasonable 12,9% for CLNXF (not so reasonable for its business), a poor 2,3% for GCTAF and a modest 4,6% for FER (but reasonable for its industry).

Table3. The Beauties KPIs, multiples and value estimate.

Despite this not-so-excellent business performance, these Beauties are traded at significant multiples. EV/NOPAT multiples (the inverse of EV Yield) for FRRVF and GCTAF is above 40x, while CLNXF is trading at an astonishing 105x multiple.

Obviously, investors are assuming that CLNXF will be able to grow its NOPAT in quite an astronomic fashion in order to make a good investment out of it. Weather that is realistic or not, specially compared to what the company has actually performed in the last four years is to yet to be seen.

What if we try to do a conservative value estimate on the three Beauties?

I usually make a quick first approach estimate of value by taking their current sales, projecting them into the future at their historical growth rates (with a 8-10% cap) and applying the last NOP margin to the resulting revenue figure. I multiply the resulting NOP figure after taxes by 10x, deduct debt and add cash in the company.

Applying this to the three Beauties (see “Est.Value” column in Table3), we get to values that differ substantially from their market appraisal. For example, on the case of CLNXF the projected NOPAT at 10x is smaller than the current net financial debt in the company as of Dec17. Therefore, it’s equity estimated value is negative.

Trying to guess what investors in CLNXF are thinking, we can make the computation in reverse, so we can work ou what is the necessary growth in revenues to achieve a 10x EV/NOPAT multiple. In the case of CLNXF this CGAR would need to be 120% for each of the coming 3 years, or 60% if we are able to wait 5 years.

That is far from the 18.9% CGAR that the company has achieved from 2013 to 2017 so I would be skeptic about the possibility to make a good investment out from CLNXF at least from this first sight valuation.

The rejected Uglies

Now we can move to the top of the list and check what is going on with the three companies less appraised by the market. The three Uglies are International Consolidated Airlines (BABWF- IAG in FT), the BA and Iberia merged airline, Mediaset ( GETVF - TL5 in FT), a private TV group, and Cie Automotive ( CIE in FT ) an auto-parts industrial producer.

Some key performance metrics and valuation multiples for these three companies are summarized in Table4:

Table4. Uglies' KPIs, multiples and value estimate.

In terms of performance we can observe that:

  1. Growth in revenues has been modest for BABWF and GETVF, both on the 4-5% range, and quite high for CIE, with a 21% CGAR for the last four years. On average (10.4%) they are well below the growth achieved by the Beauties (18.8%).
  2. On the contrary, the growth achieved in NOP has been remarkable and well above the Beauties. NOP of BABWF has grown at an astonishing 46% CGAR for 4 years, 37% for GETVF and 26% for CIE.
  3. Given that NOP has grown well above revenues, NOP Margins are reasonably high with 13% for BABWF, 25% for GETVF and 10% for CIE, probably at the top of the range of each company’s industry.

In terms of valuation there is a sharp contrast with the Beauties and their own performance. The average EV/NOPAT multiple for the Uglies is 8.5x compared to the 64x of the Beauties, almost 8 times less.

The ranking approach made by Greenblatt is useful for highlighting these huge differences within the same market. It’s like they were traded in different worlds.

It’s difficult to imagine that the same investors invest in the Beauties and the Uglies. The answer is that probably they don’t, except for index and passive investors. It’s quite obvious that there are investors that run from the Uglies with the same impatience that they chase the Beauties.

I can imagine several reasons that make the Uglies trade at those depressed multiples:

  • BABWF, the UK based airline (British Airways, Iberia, Vueling, Aer Lingus and others) has been living through a great recovery cycle from the crisis in Spain and has been enjoying a depressed oil price since 2015, hence the growth in NOP above growth in revenues. But as of now the UK based is facing a cooldown of the growth cycle and the Brexit challenge, since nobody know how much its operations can be affected by it.
  • For CIE Automotive, engaged in the production of bio-fuels, as well as in the supply of components and sub-assemblies for the automotive industry, everything can look uncertain for the future. With the Auto industry full of transformation risk and the downturn of its past decade growth markets, that is China and USA.
  • Regarding GETVF probably the market is focused on the impact of pay-tv in Spain and Netflix growth besides the decline of the traditional publicity business.

So, let’s check what could be a quick initial value estimate of these companies and compare them to how they are worth in the market. Applying the same method explained before for the Beauties, we can see (check "Est.Value" column in Table4) that the company where the difference is biggest is BABWF.

At 10x NOPAT the estimated value of BABWF is $29.5bn, way more than the $15,3bn of its cost if bought in the market.

Uglies vs. Beauties

BABWF’s EV at current market price is $16.9bn and the company delivered $3.5bn of NOP in 2017 which would yield a 15.3% un-levered return after taxes in 2018 only by repeating the NOP obtained in 2017.

But obviously the market is probably concerned about what happens if its NOP falls, specially those currently invested in one of the Beauties. Well for BABWF's EV Yield to equal the EV Yield of CLNXF, at the other extreme of the ranking, its NOP would need to fall by 94%.

Has anybody any doubt that the Brexit will impact BABWF? I don’t think so. Does anybody think it can impact in more than 94%? I don’t think so either.

But what happens if NOP falls by 20%? Well, the EV Yield would come down to a respectable 12%. And what about a 40% fall? The EV Yield would come down to an modest, but still acceptable, 9% yield.

We can now ask ourselves what has to happen in CLNXF in order to reach that 9% EV Yield? It would have to reach $800mln (9% of its $8.9bln EV) which is to say that its NOP has to multiply itself by 9.5 times from the $112mln of 2017.

Both scenarios lead to the same result, a 9% EV Yield:

  • That the NOP of BABWF falls more than 40%, after having grown 46% CGAR on last 4 years, or
  • That CLNXF’s NOP multiplies by 9.5 times in (equivalent to 380% CAGR in 4 years) after having grown at 0.5% CGAR the last 4 years.

The investor has to decide which of them is more probable. It's quite probable that BABWF’s growth is lower in the coming years than in the recent past, and even falls, but it is way more improbable, in my view, that suddenly CLNXF capacity to make its NOP grow multiplies itself exponentially from $112mln in 2017 (coming from 110 in 2013) up to $800mln,


The market is what all investors make of it, and I tend to think they have more than extrapolated past revenues growth of the three Beauties (as if they were profits) or they must have given up the possibility of making a decent return on their investments just for the privilege of being married to one of these Beauties.

Greenblatt's formula provides a good starting point for a first-sight into the market and is quite useful showing the huge differences between the cheaper-less-appreciated companies and the attractive beauties of the very same market. It is also useful, in my view, because it provides an structured way to initiate the stock picking process.

This quick analysis is not a company by company valuation and as I said I only took available information from the FT without a proper diligence. I don’t pretend to tell anybody to buy BABWF, or sell CLNXF, because of these ratios.

I just wanted to see how Greenblatt’s formula looked in my home market. If I had to look for opportunities in the index I would start analyzing the top of the list, with companies like BABWF, TL5, TNISF or MT (yes Arcelor Mittal is also part of IBEX35) all of which show to have market values bellow a conservative multiple to their projected NOPs as can be seen in Table5.

In a couple of years it will be worth revisiting this exercise and check what did happen with our three Beauties and Uglies.

Table5. KPIs, multiples and value estimate for non-financial constituents of IBEX35

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.