Magic Formula in Investing by Joel Greenblatt

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You might have heard of many legendary investors but today we're going to talk about someone truly remarkable.

While his teachings have influenced countless investors, his name remains relatively unknown to many

 I'm referring to Joel Greenblatt.

Who is Joel Greenblatt?

Joel Greenblatt, born on 13 December 1957, is a renowned American investor known for value investing and hedge fund management.

At 27, he founded a hedge fund, delivering an average annual return of 40% over 20 years to put that into perspective that's like turning ₹10 lakhs into ₹83.6 crores!

He now co-manages Gotham Funds with Robert Goldstein..

Mr. Greenblatt started his career focusing on special situations like mergers and spinoffs, spotting opportunities others missed, and taking concentrated positions with a strong margin of safety.

His expertise led him to spend over two decades as an adjunct professor at Columbia Business School, where he taught the highly regarded course "Value and Special Situation Investing."

In fact, he has written a book on his experiences with special situations

There he explains that these scenarios often result in mispricing due to their complexity and limited coverage by analysts, offering retail investors opportunities to generate alpha.

Despite all his success in special situations, he is even more widely known for his other book.

The Little Book That Beats The Market

In this book, he introduced the Magic Formula, a systematic and quantitative strategy designed to identify high-quality stocks.

This approach relies on two key metrics for screening:

»Earnings Yield (Value)

»Return on Capital (Quality)

Now once you have calculated both the metrics you need to give ranks to the stocks in your universe

»Rank for earnings yield (higher is better)

»Rank for return on capital (higher is better)

Post that, these ranks are then combined, & the companies with the lowest combined rank are considered the best according to the formula.

From this refined list, the top 20-30 companies can be selected to create a diversified portfolio.

This strategy helped him achieve a 23.8% CAGR return over 1998-2008, where the S&P 500 gave 9.6% CAGR.

The Greatness in formula:

Interestingly, Joel Greenblatt developed the MAGIC FORMULA by reverse-engineering Warren Buffett's approach of buying high-quality businesses.

High Return on Capital: Shows company efficiently use their capital to generate profits.

And refining it with his philosophy of ensuring they are available at an attractive value

High Earing yield: Shows company generates a lot of earnings relative to its market price!

The Limitations

Hence you need to be careful with this adjusments when screening using "THE MAGIC FORMULA”

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Wealth Operators