Recently, I finished reading the book “Quantitative Value” by Wesley Gray. I think the book is well written with a lot of quotes from famous value investors. It is interesting that he provides the quantitative way to screen moat stocks, which includes
- CFOA = SUM(8-Yr FCF) / Total Assets (FCF = Net Income + D&A – WC Change – Capex)
- 8-Yr geometric ROA
- 8-Yr geometric ROC (ROC = EBIT/(Net PP&E + Net WC))
The reason to use 8 years is that you want to include the whole business cycle. The reason to use geometric is to exclude very cyclical businesses that could have extremely high return in a few years but negative return in down years. In the end, you can rank each screen and assign the value to it. The sum of three screens will provide the best moat stocks.
The most powerful screen that the author found out is actually just EBIT/EV from magic formula, which beats all other factors. The book was published in Dec, 2012. The author actually launched a quantitative fund (ticker: QVAL) based on his research. QVAL was launched in Nov 2014. Unfortunately, the performance of QVAL was not good, with annualized return of -0.2% vs. S&P’s 8.8% over the same period.
Despite that, I think these 3 quantitative screens are still useful tools to screen moat stocks.