Magic Formula Screen
|Magic Formula||S&P 500|
|Five Year Return:||5.6%||14.4%|
|Ten Year Return:||5.9%||6.1%|
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 a 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.
Finding Bargain Prices
To those familiar with the value investing style of Benjamin Graham, the latter point is fairly obvious: buy stocks at a lower price than their actual value. This assumes you are able to somewhat accurately estimate a company's actual value based on future earnings potential.
Greenblatt says that stock prices of a firm can experience "wild" swings even as the value of the company does not change, or changes very little. He views these price fluctuations as opportunities to buy low and sell high.
He follows Graham's "margin of safety" philosophy to allow some room for estimation errors. Graham said that if you think a company is worth $70 and it is selling for $40, buy it. If you are wrong and the fair value is closer to $60 or even $50, you will still be purchasing the stock at a discount.
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