Magic Formula Investing

The Little Book That Beats The Market
by: Joel Greenblatt

It was a milestone book in value investing. In a short 155 pages that can be read in 2 hours and understood by anyone, Mr. Greenblatt concisely lays out a simple investment strategy where stocks are picked by only 2 factors: pre-tax return on tangible capital (ROTC), and earnings yield. A high ROTC is a sign of a good company. A high earnings yield is a sign of a cheap stock. The "Magic Formula" simply ranks all U.S. stocks by both metrics, adds them together, and buys the highest ranked stocks.

Simple, right? And to simplify things even more, Mr. Greenblatt advises to buy 5-7 stocks every few months, holding them for a year and then selling, replacing with new picks. He even created a website, www.magicformulainvesting.com, that lists all the current stocks by his rankings.


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

1. Establish a minimum market capitalization (usually greater than $50 million).
2. Exclude utility and financial stocks
3. Exclude foreign companies (American Depositary Receipts)
4. Determine company's earnings yield = EBIT / enterprise value.
5. Determine company's return on capital = EBIT / (Net fixed assets + working capital)
6. Rank all companies above chosen market capitalization by highest earnings yield andhighest return on capital (ranked as percentages).
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 long-term (3-5 year) period.