![]() Earnings Yield = (pre-tax operating earnings)/(enterprise value = market value of equity* + net interest-bearing debt).Return on Capital = (pre-tax operating earnings)/(tangible assets employed or Net Working Capital + Net Fixed Assets).This is how Greenblatt determines stocks that fit the criteria: With these rules in hand, the next common question that investors would ask is “how high is high?” In other words, a higher earnings yield is better than a lower one.” The Math of Magic Formula Investing One way to do this is to purchase a business that earns more relative to the price you are paying rather than less. ![]() “Paying a bargain price when you purchase a share in a business is a good thing. In this way, you can buy the best companies at a low price. There are times to exploit Mr Market’s unstable emotions that is, to buy from him when he is depressed about stocks. ![]() He opined that “Mr Market” is irrational in the short term, but in the long run, he actually values stocks close to their true value. Greenblatt mentioned Benjamin Graham’s concept of “Mr Market”. In other words, businesses that earn a high return on capital are better than businesses that earn a low return on capital.” #2 Buy cheap stocks at bargain prices, with High Earning Yields One way to do this is to purchase a business that can invest its own money at high rates of return rather than purchasing a business that can only invest at lower ones. “Buying a share of a good business is better than buying a share of a bad business. Here’s an insightful quote from the book: Hence, it makes sense to buy stocks of companies that can make the most profit with the least capital. Business owners must know how to deploy their funds effectively. The primary purpose of businesses and companies is to maximise the returns of their working capital. Let’s see how these work: #1 – Buy Good Companies: High return on Capital ![]() Find Cheap Companies – the Magic Formula defines a cheap company as one with High Earning Yields.Find Good Companies – the Magic Formula defines a good company as one with High Return on Capital.Hence, there are just 2 rules to Magic Formula Investing: Well, the magic formula rules are simple, but they are also reasonable and logical. Now, many of you would be skeptical – how can there be a magic formula? If only life could be so simple. It combines the best value investing ideas from both Benjamin Graham ( buying cheap businesses) and Warren Buffett ( buy wonderful businesses). In a nutshell, the Magic Formula is about buying good companies at bargain prices. He first introduced the Magic Formula in his book, The Little Book that Beats the Market. He designed a system to invest in stocks that consistently beat the market averages, which he coined the “magic formula”. 3) It is dependent on the projected profitability of companiesĪ hedge fund manager and adjunct professor at Colombia Business School, Joel Greenblatt runs Gotham Funds, an equity management firm.Īlthough he isn’t as famous as Warren Buffett or Ray Dalio, Joel Greenblatt is one of the forerunners in modern value investing.2) It hedges on the performance of several stocks.1) You need to be consistent over the long term.3 Caveats for investing with the Magic Formula.2) Improve your picks with Qualitative Analysis.2 things to look out for when implementing the Magic Formula.Top 10 Singapore Magic Formula stocks listed in SGX.How to screen for Magic Formula stocks?.#2 Buy cheap stocks at bargain prices, with High Earning Yields.#1 – Buy Good Companies: High return on Capital.
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