Wednesday, February 22, 2006

Magic Formula Investing

Some people may have noticed the "Magic Formula" investing link on the right-hand side of my blog and wondered what that was all about. Well, the so-called "Magic Formula" is Joel Greenblatt's attempt to show two very basic key elements for outperforming the market.

Joel Greenblatt ran Gotham Capital for many years, producing a phenomenal 40% annual return. He has also written two books, the latest of which is the companion explanation to the "Magic Formula" investing site (although you don't have to read the book to benefit from the site). In short, he's a man with very serious credentials and practical experience. The stocks his "Magic Formula" picks ares ones that, in the aggregate, are able to outperform the market because they display two key attributes, which are:
  • They have demonstrated that they have earned a very high return on their capital, and
  • They are cheaply priced (by the inverse of the pe ratio, called the earnings dividend [this is quite different from a dividend yield]).

Back-testing by Professor Greenblatt (yes, he also teaches now, out of Columbia University) has shown a 30% annualized rate of return over the past few decades using the "Magic Formula."

I think that any value investor would recognize the aforementioned attributes as clearly offering potential for great investment returns, and Mr. Greenblatt's research confirms it. The link takes you to a screen that automatically generates the best of these prospects, depending upon certain parameters you enter. I highly recommend this site as a place either to invest on what I might call the Magic Formula "Index", or to use these as leads to uncover potentially lucrative stock prospects.

One more word about Mr. Greenblatt - he has invested his own money to "raise the median" in the New York public school system - a man after my own heart. Read the very fascinating story and the tremendous results he has achieved with the relatively small investment of $1,000 per student per year. We salute Mr. Greenblatt's attempts to "raise the median", both socially and economically!

Magic Formula - check it out ...


The Confused Capitalist


Hendrik Oude Nijhuis said...

I have read hundreds of books on value investing, Warren Buffett etc, and publish investment tutorials on value investing myself. I highly recommend Greenblatt’s ‘the little book that beats the market’. It could be one of your best investments ever!

Success in investing,
Hendrik Oude Nijhuis

steve said...

The book is one of the simplest distillations of value investing available. I think the process outlined in the book applies to beginning investors looking to improve mutual fund returns.

It offers value to experienced investors also, providing a screen of promising investments for further research.

Here is a site providing some research on MFI stocks.