Magic Formula - Joel Greenblatt

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Magic Formula - Joel Greenblatt

Postby SHARK » Fri Apr 13, 2018 12:36 pm

What is Joel Greenblatt Magic Formula?

Joel Greenblatt is Background A widely respected hedge-fund manager. Joel Greenblatt, started as a value purist but was influenced by Warren Buffett's view about growth being part of the value equation. He founded Gotham Capital, a fund which apparently returned over 40% annualized from 1985 to 2005. By 1995, it had returned all money to its outside investors. He has authored two books, "You Can Be a Stock Market Genius" and New York Times bestsellier, "The Little Book That Beats the Market," and is also adjunct professor at Columbia University Business School. Greenblatt espouses MFI as a do-it-yourself version of the approach he has used while amassing his investment track record. With the "Little Book," Greenblatt wanted to write a book his children could read and learn from. The main point Greenblatt makes is that investors should buy good companies at bargain prices.

Magic Formula Investing uses return on capital and earnings yield as its inputs. Return on capital is seen as the best determinant of whether a business is a good one or not. Companies that can earn a high ROC over time generally have a special advantage that keeps competition from destroying it (e.g., name recognition, a new product that is hard to duplicate or a unique business model).

Earnings yield is the metric that shows whether a company is cheap or not. Greenblatt says that stock prices of a firm can experience "wild" swings even as the value of the company stays relatively constant giving investors opportunities to buy low and sell high.

Calculation/Definition of the Magic Formula:

1. Define minimum Market Capitalization that meets your liquidity needs. Greenblatt used a market capitalization floor of $50 million, but advised that you can set the minimum as high as $5 billion.
2. Sector Filter: Due to their unique financial structures, all stocks in the financial and utility sectors are excluded. Calculate Earnings Yield = EBIT / enterprise value.
3. Calculate Return on Capital = EBIT / (Net fixed assets + working capital)
4. EY Rank: Rank the stocks in descending order based on Earnings Yield and assign a rank number to each.
5. ROC Rank: Rank the same stocks in descending order based on Return on Capital and assign a rank number to each.
6. Add the rankings and select stocks that have the lowest combined ranking score. So a company that is ranked 358nd best in terms of ROC and 122rd highest in EY would gets a better combined ranking (i.e., 470) than a company that is ranked 1st in ROIC but only 950th best in EY (i.e., 951).
Price is what you pay. Value is what you get.”

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Re: Magic Formula - Joel Greenblatt

Postby SHARK » Fri Apr 13, 2018 12:59 pm

On Wall Street, Joel Greenblatt was known as a legendary stock-picker. His hedge fund, Gotham Capital, gave an average return of 50% a year over ten years. In fact, when he published his first book, 'You Can Be A Stock Market Genius', many hedge funds claimed they were following his approach. Then, he wrote his second book, 'The Little Book That Beats the Market', for small investors, in which he gave a simple methodology for picking stocks. He called it the magic formula.

The formula stands on two ratios.
First, the company's earnings before interest and taxes (EBIT) as a proportion of its net fixed assets plus net working capital; this ratio is akin to adjusted return on capital employed (RoCE).
Second, the company's EBIT as a proportion of its enterprise value; this is akin to earnings yield adjusted for capital structure.

He used to make two lists of stocks, one on the basis of earnings yield and the second on the basis of RoCE, and finally a third one adding rankings from the earlier two lists.
Price is what you pay. Value is what you get.”

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Re: Magic Formula - Joel Greenblatt

Postby SHARK » Fri Apr 13, 2018 1:10 pm

Price is what you pay. Value is what you get.”


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