Friday, November 6, 2015

Joel Greenblatt's Magic Formula simplified

The Ingredients to the Magic Formula

Here is the formula courtesy of wikipedia. From beginning to end, it consists of 9 steps.
1. Establish a minimum market capitalization (usually greater than 1000 Cr.).
2. Exclude utility and financial stocks
3. Exclude foreign companies
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.

Pay close attention to step 4 and 5 because they are the key driving formulas for it all to work.