- Long-term risk-free rate of around 6% on a 10-year government bond. Thus, risky investments need to yield an absolute minimum of 6% return.
- Magic Formula: buy good companies at bargain prices—i.e. buy businesses that earn a high return on capital with high earnings yield. Normalize the latest year earnings to “normal” year earnings. Choose stocks that have the best combination of both of these ranks.
- Go to magicformulainvesting.com website for stock screens. Screen for ROA (may substitute for return on capital) > 25%. Then screen for the lowest P/E (may substitute for earnings yield). Eliminate utilities, financials, and ADRs
- Magic formula is thoroughly researched and robust. Increasing returns for progressing deciles of increasingly attractive ranks.
- Works over the long-term and may not work well over short-term periods of several years. Two to three years is normally enough time for Mr. Market to price things right. The key is to have patience and stick with the strategy. However, most investors won’t or can’t stick to the strategy.
- Companies that earn a high return on capital may also have opportunities to reinvest their profits at a high rate of return. This opportunity is valuable and can contribute to high earnings growth. These companies are likely to have a special competitive advantage of some kind.
- Starting early in investing is critically important to take advantage of the effects of compounding.
- Greenblatt feels 95% of trading in the markets is unnecessary from a productivity standpoint, after a minimum level is necessary to achieve adequate liquidity. Spend time doing something worthwhile and meaningful—give back!
- The magic formula works amazingly well, even better than Professor Haugen’s 71 factor model. It distinguishes top and better deciles better, has a better 36-month negative return, and requires only yearly (not monthly) rebalancing.
Finished: 27-Jul-2006