I was recently reading up on Joel Gleenblatt, a famous value investor, and I came across his magic formula investing strategy. Greenblatt discussed about this investment strategy in his book – The Little Book that Beats the Market. Using this formula, Greenblatt said that he was able to beat the S&P 500 96% of the time, and he averaged a 17 year annual return of 30.8%. The magic formula consists of 9 steps. In this blog post, I will go over those 9 steps. Let’s dive in.
- Use a stock screener to look for stocks with a minimum market capitalization of at least $100 million.
- Exclude any financial or utility stocks as they have unique business models.
- Exclude American Depository Receipts (ADRs), which are stocks in foreign companies.
- Calculate each company’s Earnings Yield i.e. EBIT / Enterprise Value.
- Calculate each company’s Return on Capital i.e. EBIT / (Net Fixed Assets + Net Working Capital).
- Rank the above filtered companies by the highest earnings yield and the highest return on capital.
- Invest in the top 20-30 companies by buying 2-3 positions each month over the course of the year.
- Rebalance the portfolio each year by selling off losers one week before the year-term ends and selling off winners one week after the year mark.
- Repeat the process each year for a minimum of 5-10 years, if not more.
If you think steps 1-6 are time consuming, you can simply use the “magic formula” screener available at www.MagicFormulaInvesting.com. When I used the screener, I filtered a list of 30 stocks which have a market capitalization of more than $100M and would be ideal for this investment strategy. I have attached a screenshot of those 30 stocks below:
Now that we have the top 30 stocks in our hand, steps 7-9 should be petty easy. Let’s say you have $3000 to invest. One way you could go about buying these 30 stocks is by buying $100 worth of each stock. This means that you would buy 10 shares of a company trading at $10/share, 5 shares of another company trading at $20/share, or 1 share of some other company trading at $100/share. In other words, you want the dollar amount that you invest in each company to be the same. Once you buy these stocks, you essentially hold them for one year and then you sell those holdings; by waiting for one year, your after tax returns are maximized. You repeat this process for 5-10 years, which might be a harder step. You will just have to be patient when following this strategy. That’s all!
Hope you learned a little and found this blog post helpful. We talked about the 9 steps that Joel Greenblatt outlines in The Little Book That Beats The Market. He calls this investing strategy as the Magic Formula Investing. We also showed the top 30 stocks that meet his investment criteria. As always, you can sign up for our mailing list here. Like us on our Facebook page here. Thank you!
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Superior North LLC’s content is for educational purposes only. The calculators, videos, recommendations, and general investment ideas are not to be actioned with real money. Vyom Joshi is not a professional money manager or a financial advisor. Contact a professional and certified financial advisor before making any financial decisions.