Magic formula investing


Magic formula investing is an investment technique outlined by Joel Greenblatt that uses the principles of value investing.

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', claiming that it does in fact beat the S&P 500 96% of the time, and has averaged a 17-year annual return of 30.8%.

Formula

  1. Establish a minimum market capitalization.
  2. Exclude utility and financial stocks.
  3. Exclude foreign companies.
  4. Determine company's earnings yield = EBIT / enterprise value.
  5. Determine company's return on capital = EBIT /.
  6. Rank all companies above chosen market capitalization by highest earnings yield and highest return on capital.
  7. Invest in 20–30 highest ranked companies, accumulating 2–3 positions per month over a 12-month period.
  8. Re-balance portfolio once per year, selling losers one week before the year-mark and winners one week after the year mark.
  9. Continue over a long-term period.