Magic Formula Investing
From Wikipedia, the free encyclopedia
Magic Formula Investing is a term that refers to an investment technique outlined by Joel Greenblatt. Although Magic Formula Investing[1] is firmly rooted in the principals of value investing, for the lay investor it is claimed that it offers market beating returns without the complexity associated with a discounted cash flow analysis.
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[edit] Methodology
Greenblatt suggests purchasing 30 Good Companies: cheap stocks with a high earnings yield and a high return on capital. He touts the success of his magic formula in his book The Little Book that Beats the Market[2], citing that it does in fact beat the market 96% of the time, and has averaged a 17-year annual return of 30.8%[3]. The comparison index used for "the market" in Greenblatt's research is the S&P 500.
[edit] Formula
- Establish a minimum market capitalization (usually greater than $50 million).
- Exclude utility and financial stocks
- Exclude foreign companies (American Depositary Receipts)
- Determine company's earnings yield = EBIT / Enterprise Value.
- Determine company's return on capital = EBIT / (Net fixed assets + working capital)
- Rank all companies above chosen market capitalization by [highest earnings yield and highest return on capital] (ranked as percentages).
- Invest in 20-30 highest ranked companies, accumulating 2-3 positions per month over a 12-month period.
- Re-balance portfolio once per year, selling losers one-week before the year-mark and winners one-week after the year mark.
- Continue over long-term (x>3 to 5 years) period.
[edit] Using Magic Formula Website
- Choose preferable market capitalization level.
- Invest in 30 companies from Magic Formula Investing, accumulating 2-3 positions per month over a 12-month period.
- Follow steps (8-9) above.
[edit] References
- ^ Magic Formula Investing Website
- ^ The Little Book That Beats The Market, Joel Greenblatt ISBN 0-471-73306-7
- ^ Zen, Brian and Hamai, Garrett. "Joel Greenblatt Speaking at NYSSA". December 28, 2005.
[edit] External links
[edit] Greenblatt-sponsored sites
- Magic Formula Investing Website, "...the magic formula site was created to make the process easy and accessible to as many investors as possible.", Official Magic Formula website, Joel Greenblatt
- Value Investors Club, created by Gotham Capital
[edit] Magic Formula in the Media
- Magic Formula Of Little Book Just May Work, November 9, 2005, Jesse Eisinger, The Wall Street Journal
- A magic formula, The Daily Reckoning, United Kingdom edition, Fleet Street Publications, January 9, 2006, Chris Mayer
- The Little Book's Little Flaw, Bill Alpert, Dow Jones, March 25, 2006
- An Evening with Mr. Greenblatt, interview by Shai Dardashti, www.gurufocus.com, January 11, 2006
[edit] Website Tools
- Joel Greenblatt stock picks and portfolio holdings, Guru Focus, website
- Discussion Board, Magic Formula Investing, The Motley Fool
