Our investing philosophy has always been about investing, not trading. We want to buy shares in companies whose stock prices we believe will, over the long-term, grow because the underlying business is growing, not because we’re capitalizing on trading momentum or arbitrage.
That means we want to invest in companies that we think are investing wisely in themselves.
Capital efficiency measures both the quality of a business and its fundamentals by asking a simple question: Are they spending money to make money? It’s one way to separate companies we believe are high-quality, long-term performers from trendy, flash-in-the-pan winners whose wins can easily dissipate.
We calculate it a little differently
We aren’t the only ones interested in capital efficiency—everyone wants to invest in businesses that invest their capital wisely. Mostly, investors are looking for gross profitability, or the amount a business earns minus what it spends to sell or make its products and/or services.
We take gross profitability a step further to include total assets. There’s a reason for that: Total assets would include balance sheet items like cash, accounts receivable, and inventory. Those represent what a company owns and uses to generate those gross profits.
Say there are two companies with gross profits of $100 million. The first one has total assets of $100 million and the second has total assets of $1 billion. The first company would have a "Capital Efficiency score" of 1 (Capital Efficiency equals gross profits divided by total assets) and the second would have a capital efficiency score of 0.1. The scores represent to us that the first company is 10 times better at generating gross profit from its assets than the second company. Our Capital Efficiency score favors capital-light businesses that can effectively generate gross profit with a lean balance sheet.
But even that isn’t enough. You see, any company can be capital efficient for a short period of time. We want to invest in companies that we believe will be capital efficient for years, even decades, to come.
While past performance is no guarantee of a future result, we feel that what a company’s management team has done is the best predictor of what it will do. So we’re looking not just for gross profitability and total assets, but Capital Efficiency that we believe is stable, significant, and trending in the right direction.
Meet TMFE
The Motley Fool 100 Capital Efficiency Index ETF (TMFE) offers exposure to 100 high-conviction stock picks weighted according to their Capital Efficiency scores by tracking a people-powered, smart beta index. It’s an unusual combination, we know, but that’s why we believe it’s powerful.
Before a company even meets the smart beta formula to become part of the Motley Fool Capital Efficiency 100 Index, it must meet the criteria of The Motley Fool, LLC Recommendation Universe—a pool of stocks that are active recommendations by The Motley Fool, LLC or are among the 150 top-ranked companies in The Motley Fool, LLC Analyst database, Fool Intel.
That means each and every holding in the index has been hand-selected by a real person. The Motley Fool, LLC professional analysts spend hours researching and recommending what they believe are some of the highest-quality companies in the marketplace today.
Only then does the index layer in the Capital Efficiency smart beta formula identify 100 companies from those recommendations, filtering down to the ones they believe have the strongest profitability, best growth trends, and most consistent track records.
TMFE replicates the index with an added layer of diversification: Each security in the ETF is capped at 4.8% during the quarterly rebalancing to limit single security risk and give investors better exposure to more sectors.
And, historically, it has worked. The one-year performance to date, for the fiscal year ending October 31, 2024, is over 40%.
We believe in the Motley Fool 100 Capital Efficiency Index’s ability to find long-term winners—and to deliver them to you in one convenient, cost-effective ETF.
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