Magic Formula Investing

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rjonesx
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Definition

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

Magic Formula Investing

What is ‘Magic Formula Investing’

A money-making strategy that teaches investors a common-sense method for value investing in the stock market that is designed to beat the market’s average annual returns. The Magic Formula strategy is described in the best-selling book “The Little Book That Beats The Market” (1980) by investor and Wharton graduate, Joel Greenblatt.

Explaining ‘Magic Formula Investing’

Investors can use Greenblatt’s online stock screener tool to select 20 to 30 top-ranked companies, based on their earnings yield and return on capital, in which to invest. These will all be large companies, and no financial companies, utility companies or non-U.S. companies will be included.

Investors sell the losing stocks before they have held them for one year to take advantage of the income tax provision that allows investors to use losses to offset their gains. They sell the winning stocks after the one-year mark, in order to take advantage of reduced income tax rates on long-term capital gains. Then they start the process all over again.

Magic Formula Investing FAQ

Does the magic formula investing work?

The Magic Formula is famous for returning a 30% CAGR. From 1988 to 2004, it achieved a 30.8% return, but the CAGR has declined significantly. No strategy can sustain a CAGR of 30%.

Is Magic Formula Investing free?

The Magic Formula stocks are free in Joel Greenblatt’s website, MagicFormulaInvesting.com.

What is Greenblatt’s magic formula?

As Greenblatt stated, the magic formula is to help investors with “buying good companies, on average, at cheap prices, on average.” Using this straightforward, non-emotional approach, investors screen for companies with good prospects from a value investing perspective.

How do you calculate magic formula?

Their stock’s earnings calculated as earnings before interest and taxes (EBIT), yield calculated as earnings per share (EPS) divided by the current stock price, return on capital which measures how efficiently they generate earnings from their assets.

What does magic formula mean?

A simple and sure way to an end.

Further Reading

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