Computerized Investing > Third Quarter 2009

Using the Magic Formula for Investing

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by Cara Scatizzi and AAII Staff

Learning to successfully invest in the stock market is simple, according to Joel Greenblatt’s “The Little Book That Beats the Market” (Wiley, 2005). Greenblatt is the founder and a managing partner of Gotham Capital, a private investment partnership. He is an adjunct professor at the Columbia University Graduate School of Business, and holds a B.S. and an MBA from the Wharton School.

Greenblatt wanted to write an investing book his children could read and learn from. The main point Greenblatt makes is that investors should buy good companies at bargain prices—businesses with high return on investment that are trading for less than they are worth.

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Joseph from MN posted over 6 years ago:

I have bought and read Joel Greenblatt’s book, and occasionally visit his web site

for ideas. His methodology has been very useful for investing my mother's trust which is managed for income and capital preservation.

John from NJ posted over 6 years ago:

For tangible capital, you should also include net PP&E. As it stands now, the formula for tangible capital only has working capital, which gives capital intensive businesses a free ride when determining ROIC. Another perspective on the formula would subtract goodwill/intangibles from total assets. As I recall, JG uses working capital plus net PP&E to calculate tangible capital.

Dale Stemen from OH posted over 4 years ago:

Why are the companies list different than :

Duncan from DE posted over 4 years ago:

Has anyone actually applied the system reommnended in the Greenblatt book? I have had a protfolio for nearly 3 yrs which is the minimum that JG recmmends for testing the results. I have dutifully followed the instructions for buying and selling the recommended stocks (using the website). My results are SLIGHTLY better than if I had bought the S&P index in the amounts and dates when I purchased the stocks. However, my results do not approach those indicated in the book which were generated by back-testing the formula system. JG quotes retruns of 10% to 20% greater than the S&P 500 (I believe these are annualized or averaged results on pages 59, 64, 155 of the 2010 book.
I have seen reports of other academic attempts at duplicating the book's back-testing results; at least one such report states that their results also do not approach those qouted in the book. In fact, the report matches my experience that the system beats the averages buy by only a bit. The report author states the politically correct conclusion that though the results differ dramatically from those in the book, this may be due to ""stability" issues with back-testing methodology. I'm thinking the book greatly exaggerates results that can be expected in practice. I wielcome any opinions or comments.

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