Magic Formula Screen
Joel Greenblatt\'s Magic Formula Screen
Quick Screen Summary
In the book "The Little Book that Beats the Market", Joel Greenblatt came up with a simple way to screen and invest in stocks.
The Magic Formula screener methodolgy he outlined is as follows:
- Establish a minimum market capitalization (usually greater than $50 million)
- Exclude utility and financial stocks
- Exclude foreign companies (American Depositary Receipts)
- Determine company’s earnings yield = EBIT / enterprise value
- Determine company’s return on capital = ebit / (net fixed assets + working capital)
- Rank all companies above chosen market capitalization by highest earnings yield and highest return on capital (ranked as percentages)
- Invest in 20–30 highest ranked companies, accumulating 2–3 positions per month over a 12-month period
- Re-balance portfolio once per year, selling losers one week before the year-mark and winners one week after the year mark
- Continue over a long-term (3–5+ year) period
The two key points of the Magic Formula stock screen is based on:
Earnings Yield = EBIT / Enterprise Value
Return on Capital = EBIT / (Net Fixed Assets + Working Capital)
To get the full performance details from 1988 read the link below.
Read more: Does the Magic Formula Screen work?