Joel Greenblatt is a renowned fund manager and professor at Columbia. One of the reasons behind his popularity is the introduction of his magic formula for investing, in The Little Book That Beats the Market. Aside from this, another important work of the professor is You Can Be a Stock Market Genius.
So, what is it about his magic formula that really makes it… well, magic? Is it worthy of your attention or not? Accordingly, when using his formula, he managed to obtain no less than 24 percent returns per year, during 1988 and 2009. This is, of course, what mainly contributed to the popularity of his books. To that end, if you were to invest in an index fund, then, in this case, your return would be of roughly 9.55 percent.
The Basics of the Magic Formula
The approach that is suitable for each case scenario is trying to buy companies at convenient prices. This is a golden rule you should abide by. More specifically, you should focus on including stocks whose market capitalization is of over $50 million, $100 million or $200 million. On a different note, you should exclude financial or utility stocks, as well as foreign companies and American Depositary Receipts.
In regard to the remaining stocks, Greenblatt points out the earnings yield by using the formula known as EBIT/EV. Furthermore, he determines the return on capital with the help of the EBIT/(net fixed assets + working capital) formula. Afterwards, the stocks are ranked depending on their earnings yield in connection with the return on capital.
Evidently, there are specific steps you have to follow, as pointed out by Joel Greenblatt; we have briefly mentioned some of the most important elements. If you are interested in applying his formula, you should do some research in this respect and, perhaps, purchase his book.
In addition to that, note that Greenblatt has actually created a site that can assist you in the calculations you need to make. We’re talking, of course, about www.magicformulainvesting.com. The website ranks the stocks accordingly so that they meet individual criteria.
Why Should You Follow Joel Greenblatt?
This is, obviously, a legit question you might have asked yourself several times, considering that you’ve reached this article. So, the reason why it might be a sensible choice to follow Joel Greenblatt’s approach is that he initiated the Gotham capital in 1985. And during 1985 and 1994, he managed to generate significant returns, which is surprising. Not only that he managed to return the money to the investors, but he also succeeded in maximizing the returns over a significant timeframe.
Obviously, though, there is more than meets the eye when it comes to investing, which is why it is fundamental to do your part beforehand. So, you should try to do some thorough research and see the approach that would work best for you, since there’s no such thing as an equation that functions in all scenarios.