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Hi Aptvictoria -

Maybe these notes will help clarify:

1. The asset side of the balance sheet tells you what assets are being financed, the liability & stockholders' equity section tells you how the assets are being financed.

2. The stockholders own the assets, but if any assets are financed with debt, then the creditors will have a loan agreement stating they have a senior claim on the assets if the company goes bankrupt. So to answer your question about who owns the fixed and working capital, the stockholders do provided the company stays solvent.

3. Most return on capital calculations use the right (bottom) side of the balance sheet; i.e., liabilities plus stockholders' equity. But you can also use the left (top) of the balance sheet. I use both, to double-check my work. Here are the key assets to use when estimating capital from the left (top) section of the balance sheet:

Working Capital (working capital assets - WC liabilities)
Net Fixed Capital
Net Goodwill
Net Capitalized intangibles
Capitalized Operating Leases
(Cumulative Unusual Gains A/T)
(Cumulative Extraordinary Gains)
Operating Cash
Operating Investments
Other Assets
(Construction In Progress)

4. Return on capital figures come in different gradations of precision. Joel's formula is good because most databases report net fixed and working capital. Information on capitalized operating leases is harder to find, though. And as for capitalized intangibles, forget have to do the work yourself. But there is always a tradeoff between simplicity and precision. If you looked at Joel's personal spreadsheet, I bet you would find other forms of capital, including goodwill, capitalized intangibles, operating cash, (construction in progress), etc.

5. Lots of attention has been given to the impressive results that Joel's portfolio has produced. So if mechanical investing interests you, go over to the AAII website and check out their screens. From the beginning of 1998 to the end of 2004, the Greenblatt portfolio rose 239%. AAII's Canslim portfolio, however, rose 674%. Then you have the Piotroski portfolio, which gained 1,060%. The Zweig portfolio notched the most dazzling results, up 1,278%. The S&P 500 inched up just 25% during this 7-year stretch.

My point? Based on 1998-2004 results only, there are other "dumb" portfolios that have out-performed the high return on capital/low P/E model. Another point: I am in no way criticizing Joel's book or model; both are brilliant in their simplicity.

To learn more about the AAII portfolios, go here:

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