Magic Formula Screen

Joel Greenblatt\'s Magic Formula Screen
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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:

  1. Establish a minimum market capitalization (usually greater than $50 million)
  2. Exclude utility and financial stocks
  3. Exclude foreign companies (American Depositary Receipts)
  4. Determine company’s earnings yield = EBIT / enterprise value
  5. Determine company’s return on capital = ebit / (net fixed assets + working capital)
  6. Rank all companies above chosen market capitalization by highest earnings yield and highest return on capital (ranked as percentages)
  7. Invest in 20–30 highest ranked companies, accumulating 2–3 positions per month over a 12-month period
  8. Re-balance portfolio once per year, selling losers one week before the year-mark and winners one week after the year mark
  9. 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?