![]() To decide whether a company is “cheap”, Greenblatt ranks companies based on their earnings yield. Read this article to see more ROIC stock screener metrics. Return on Capital = EBIT/(Net Fixed Assets + Net Working Capital) In turn, capital employed is the sum of net fixed assets and net working capital. Return on capital employed is calculated by dividing EBIT by capital employed. In the investment world, picking companies with these traits is known as “ quality investing“. As a result, they deliver exceptional returns over the long-term. Whatever it is, they possess characteristics that help them fend off competitors and become market leaders. This could be due to brand strength, scale, or unique products. Clearly investors should prefer the first company.Ĭompanies with high returns on capital tend to have a strong competitive moat. Compare this to a company that only earns $10k from the same investment – a return of 2.5%. If it costs $400k to build a store that will earn $200k next year, this equates to a 50% return on capital. He uses the example of a company building a store to illustrate this. Return on Capital Employedįor a company to be “good”, Greenblatt argues that it should earn a healthy return on the capital it invests. Well, to answer these questions, Greenblatt suggests focusing on two ratios: the return on capital employed, and earnings yield. How to Calculate the Magic FormulaĪs mentioned, the magic formula looks to buy good companies that are cheap. In summary, magic formula investing is a time-tested, formulaic strategy for picking stocks with strong quality and value characteristics. The application is where it gets tricky, and recent results have been much less inspiring than the original. Whilst its track-record and simplicity portray some sort of “black box” money printer, remember there is no such thing as a “magic formula” in trading. Unlike most quantitative strategies, this makes magic formula investing suitable even for beginners. That is, buy good companies (Buffett) at cheap prices (Graham). It is built on sound investment principles that have their roots in the lessons of Warren Buffett and Benjamin Graham. The strategy is both simple and intuitive. This comfortably beat the market (S&P 500) over the same period – which only earned 12.4%.īut its appeal extends further than this. He showed that over a 17-year period (1988-2004), it earned an average annual return of 30.8%. It was developed by professor and hedge fund manager, Joel Greenblatt, who outlined the investment process in his 2005 book: “ The Little Book That Beats the Market”. Past performance is a poor indicator of future performance.Magic formula investing is a rules-based investing strategy that buys companies with a high earnings yield and return on capital employed. In no event shall Alpha Spread Limited be liable to any member, guest or third party for any damages of any kind arising out of the use of any content or other material published or available on or relating to the use of, or inability to use, or any content, including, without limitation, any investment losses, lost profits, lost opportunity, special, incidental, indirect, consequential or punitive damages. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. Under no circumstances does any information posted on represent a recommendation to buy or sell a security. Is not operated by a broker, a dealer, or a registered investment adviser.
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