Fool Capital Efficiency Methodology

The Motley Fool Capital Efficiency 100 Index was developed by The Motley Fool, LLC to define and track the 100 companies that have the highest capital efficiency rating out of the most liquid U.S. companies that have been recommended by The Fool’s analysts.

The Motley Fool Capital Efficiency 100 is reconstituted quarterly, at which time each company’s share of the Index is set to equal the company’s share of all index companies’ aggregate market value tilted by the Capital Efficiency Score (the “Weighting Date”). The Index is calculated to capture both price appreciation and total return, which assumes dividends are reinvested into the constituents that issue them.

Membership Criteria

To be eligible for inclusion in the Motley Fool Capital Efficiency 100, companies must be domiciled in the United States and are either active recommendations of a The Motley Fool, LLC research publication or rank among the 150 highest rated U.S. companies in the Fool analyst opinion database, Fool Intel, subject to universe continuity rules. Liquid firms are those that have traded at least $1 million worth of shares daily, on average, during the preceding three months.

Common stocks, REITS, tracking stocks and holding companies are eligible for inclusion. ADRs, GDR, EDRs, Preferred Stocks, closed-end funds, exchange-traded funds and derivatives are not eligible.

Universe continuity rules are applied to the eligible universe during reconstitution. A buffer sized at 30% of the 150-stock conviction target - or 45 stocks - is applied to the Fool Intel universe sleeve to reduce universe turnover.

Specifically, stocks ranked in the top 105 positions based on Fool Intel conviction (70% of the 150-stock target) are automatically included in the candidate universe. Additionally, companies that were previously eligible based on their Fool Intel ratings will still be included as long as their rank is equal to or better than 195 (130% of the 150-stock target). Stocks are then added based on conviction score rank until the 150-stock target is reached.

Securities that meet the requirements for universe inclusion must also meet the minimum requirements for calculating the Capital Efficiency Score. Specifically, they must report gross profits (or net revenues for financial companies) and have total assets of at least $50 million as of the most recent filing prior to each index weighting date.

Capital Efficiency Score

The Capital Efficiency Score is the equal weighted average of three separate scores - a profitability score, a growth score, and a stability score. The construction details for each stand-alone score are provided in the table below.

Fundamental variables are calculated for each stock represented in the Index’s inclusion universe.

In order for a stock to qualify for inclusion in the Index it must possess the necessary data for calculating the Profitability (GPOA) score. In order for a stock to receive a Growth and/or Stability score, it must possess at least eight quarters of data per the minimum data requirements in the table above.

After initial calculation, fundamental variables are then winsorized at the 5th and 95th percentiles. Next, each winsorized fundamental variable is transformed into a cross-sectional z-score:

Z = $(x-\mu )⁄$_σ

Where:

The final composite Z score for a stock is an equal-weighted average of its qualifying stand-alone scores. The final Capital Efficiency Score is calculated from the composite Z score as follows:

if Z > 0 --> Capital Efficiency Score = 1+Z
if Z <= 0 --> Capital Efficiency Score = (1-Z)^-1

To determine final index membership, candidate stocks are first ranked based on their composite scores. The top 100 stocks are then selected based on the following index continuity rules. A buffer sized at 30% of the 100-stock target - or 30 stocks - is applied to the qualifying inclusion universe to reduce Index turnover.

Specifically, stocks ranked in the top 70 positions based on their Capital Efficiency Scores (70% of the 100-stock target) are automatically included in the candidate universe. Additionally, companies that were previously eligible based on their Capital Efficiency Scores will still be included as long as their rank is equal to or better than 130 (130% of the 100-stock target). Stocks are then added based on conviction score rank until the 100-stock target is reached.

Performance Calculations

The Motley Fool Capital Efficiency 100 Index is calculated every weekday. If trading is suspended while one of the three major exchanges is still open, the last traded price for that stock is used for all subsequent index computations until trading resumes. If trading is suspended before opening, the stock’s adjusted closing price from the previous day is used to calculate the Index. Until a particular stock opens, its adjusted closing price from the previous day is used in the Index computation. Index values are calculated both on a price and total-return basis, in U.S. dollars. The price index is updated on a real-time basis, while the total return index is calculated and disseminated on an end-of-day basis.

Weighting

Each component’s initial weight on the Weighting Date reflects the component’s proportion of total market-capitalization multiplied Capital Efficiency Score.

Initial Index Weight = Capital Efficiency Score * Firm Market Capitalization

The above weights are normalized to 100%. A maximum initial position limit of 4.8% is enforced, subject to the following logic:

1. Identify stocks with weights that exceed the maximum position limit
2. Set these weights to the maximum position limit
3. Reallocate the excess weight across the remaining names in a pro-rata fashion
4. Repeat steps 1-3 until no offending positions remain

Initial weights further undergo adjustments to maintain index integrity and diversification, based on the following “24/48” rules:

• If any single issuer’s initial weight exceeds 24% of the total index, that weight is adjusted down to 22%.
• Subsequently, if the aggregate weight of issuers with “concentrated positions” (above 4.8%) exceeds 48% of the total index, that aggregate weight is adjusted down to 44% and balance is pro-rated among the remaining constituents while preserving the order of initial weights.

The Weighting Date is the second to last Monday of each Calendar Quarter. These weights take effect on the Weighting Date and are price-drifted to the Reconstitution Date.

The index is tested regularly to ensure adherence to the prescribed weighting constraints above. A Special Rebalance may be announced at any moment when such action is deemed necessary for upholding the index's structural integrity.

Dividend Reinvestment

Normal dividend payments are not taken into account in the price index, whereas they are reinvested into their issuing components in the total return index. Special dividends require index divisor adjustments to prevent the distribution from distorting the price index.

Multiple Share Classes

In the event a component company issues multiple classes of common stock, the specific shares recommended by The Motley Fool, LLC will be used. If both share classes have been recommended, or if neither is specified over the other, the most liquid share class will be used.

Index Maintenance

Index maintenance includes monitoring and implementing the adjustments for company deletions, stock splits, stock dividends, spin-offs, or other corporate actions. Some corporate actions, such as stock splits, stock dividends, spin-offs and rights offerings require changes in the Index shares and the stock prices of the component companies.

Component Changes

Additions

Additions to the Index are made at the quarterly reconstitution, according to the inclusion criteria defined above. No additions are made between reconstitutions, except in the case of certain spinoffs and acquisitions, as defined below.

Delistings

If a component company is delisted, it is deleted from the Index and weights of remaining components are adjusted proportionately.

Mergers & Acquisitions

If one component company is acquired by another, treatment varies depending on the terms of the deal. If stock is used, the acquiring/surviving company’s share of the Index will be increased, to reflect the terms of the deal and the value of the acquired company. If cash is used, the value of the target company, based on its last close price, will be distributed pro-rata across the remaining index constituents. If a combination of cash and stock are used, the cash portion of the deal will be distributed, pro-rata, across the remaining constituents, and the acquiring company’s share will be adjusted based on the stock portion of the deal.

If a component company is acquired by a non-component company, the value of the target company will be distributed, pro-rata, to the remaining constituents based on its last close price.

Spin Offs

If a company is spun-off from an existing component company, it is allowed to stay in the index until the next quarterly reconstitution.

Index Divisor Adjustments

Changes in the Index’s aggregate market capitalization, due to changes in composition, weighting or corporate actions will result in changes to the Index’s divisor. Corporate actions that require divisor adjustment will be implemented prior to the opening of trading on the effective date. In certain instances, where information is incomplete or if the action is announced too close to the ex-date, the adjustment will be implemented at the close of the following day, or as soon as practical thereafter. For corporate actions not described herein, or combinations of different types of corporate events and other exceptional cases, The Motley Fool, LLC reserves the right to determine the appropriate implementation method.