What Is It?

The Magic Formula is an organized, disciplined, and unemotional approach to investing that is particularly suitable for long-term investors. It's an easy-to-follow method that can help investors achieve their financial goals with confidence.

The Magic Formula was developed by Joel Greenblatt and is described in his books "The Little Book That Beats the Market"and "The Little Book That Still Beats the Market" According to the author, the method can beat the S&P500, which is often used as a market benchmark, by providing annualized returns of over 30%. With its proven track record, the Magic Formula can be a valuable tool for investors looking to build a strong investment portfolio.

In Practice

  1. Go to the Magic Formula Investing website
    1. Create an account
    2. Go the Stock Screener
  2. Enter a value for the Minimum Market Cap for, and the number of, companies you consider investing in
    1. Companies with lower Market Capitalizations leads to greater volatility, and vice-versa
    2. More companies means more diversification and less volatility
  3. From the list, remove the companies you do not want to invest in for your personal reasons
  4. Optional: For higher return, please see here
  5. Pick the top 5* to 7* of these top companies, and invest 25%* of your total intended capital
    1. Consider Equal dollar amount for each stock
  6. Hold these stocks for one year, no matter what
    1. Do not panic sell, do not take premature profits
    2. Depending on the Capital Gains laws in your country and for tax purposes, keep winners for more than one year, and sell losers before the one-year mark
  7. Repeat all the previous steps every 3 months**
* You can pick more than 7 or less than 5 stocks depending on your allocated capital
** You can also decide to repeat the cycle more frequently than 3 months, or less frequently
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Want higher returns?

Quant Investing thoroughly back-tested the strategy by combining the Magic Formula score for each stock with different ratios. Get the highest return by combining the stocks with the highest Magic Formula score and the highest Price Index 6 Months

The backtest on the period from June 1999 to June 2011 showed a 600.5% improvement over the best return of 182.8% using the Magic Formula alone. Find the complete results here

For each company,
  1. Calculate Magic Formula Score (details here)
  2. Keep the top 20% of companies
  3. Calculate the Price Index 6 months these companies, and order the list in a decreasing order
  4. If you're a techie, use the Python script provided here
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The "Magic Formula" formula

The Magic Formula Score is determined as followed
  1. From a list of companies, remove the following ones:
    • Financials
    • Insurances
    • Investment funds
    • Utilities, specific holdings companies
    • REITs
    • American Depository Receipts (ADRs)
  2. Keep companies with a Market Capitalization of > $50M
  3. Calculate, or get, the P/E for each company
    • Low P/E ~ "Cheap Stock"
  4. Calculate the Return On Capital (ROC) for each company (or Return On Asset (ROA) sometimes)
    • High ROC ~ "Good Company"
  5. Rank each company by lowest P/E
  6. Rank each company based on the highest ROC
  7. Simply Sum the ranks for each company
  8. Order by Lowest
  9. Et voila!!
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