Magic Formula Stocks - Joel Greenblatt -- GuruFocus.com

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What is Joel Greenblatt Magic Formula?

Joel Greenblatt is Background A widely respected hedge-fund manager. Joel Greenblatt, started as a value purist but was influenced by Warren Buffett's view about growth being part of the value equation. He founded Gotham Capital, a fund which apparently returned over 40% annualized from 1985 to 2005. By 1995, it had returned all money to its outside investors. He has authored two books, "You Can Be a Stock Market Genius" and New York Times bestsellier, "The Little Book That Beats the Market," and is also adjunct professor at Columbia University Business School. Greenblatt espouses MFI as a do-it-yourself version of the approach he has used while amassing his investment track record. With the "Little Book," Greenblatt wanted to write a book his children could read and learn from. The main point Greenblatt makes is that investors should buy good companies at bargain prices.

Magic Formula Investing uses return on capital and earnings yield as its inputs. Return on capital is seen as the best determinant of whether a business is a good one or not. Companies that can earn a high ROC over time generally have a special advantage that keeps competition from destroying it (e.g., name recognition, a new product that is hard to duplicate or a unique business model).

Earnings yield is the metric that shows whether a company is cheap or not. Greenblatt says that stock prices of a firm can experience "wild" swings even as the value of the company stays relatively constant giving investors opportunities to buy low and sell high.

Calculation/Definition of the Magic Formula:

1. Define minimum Market Capitalization that meets your liquidity needs. Greenblatt used a market capitalization floor of $50 million, but advised that you can set the minimum as high as $5 billion.
2. Sector Filter: Due to their unique financial structures, all stocks in the financial and utility sectors are excluded. Calculate Earnings Yield = EBIT / enterprise value.
3. Calculate Return on Capital = EBIT / (Net fixed assets + working capital)
4. EY Rank: Rank the stocks in descending order based on Earnings Yield and assign a rank number to each.
5. ROC Rank: Rank the same stocks in descending order based on Return on Capital and assign a rank number to each.
6. Add the rankings and select stocks that have the lowest combined ranking score. So a company that is ranked 358nd best in terms of ROC and 122rd highest in EY would gets a better combined ranking (i.e., 470) than a company that is ranked 1st in ROIC but only 950th best in EY (i.e., 951).

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Manual of Stocks™

Predictability	Market Cap ($mil)	Earnings Yield (%)	Return on Capital (%)	10-Y EBITDA Growth Rate (%)	5-Y EBITDA Growth Rate (%)	P/E	Yield (%)	Rank
Currently 1/5 Business Predictability Rank: 1-Star Back Testing Results: Average gain of all 1-Star stocks: 1.1% per year. % of Stocks that are in still loss if held for 10yrs: 45%. Read more: What is Predictability Rank? Performances of real portfolio Top Ranked Predictable Companies	32.700	1254.38	12035.90	0.00	0.00	0.72	0.00	1
Currently 1/5 Business Predictability Rank: 1-Star Back Testing Results: Average gain of all 1-Star stocks: 1.1% per year. % of Stocks that are in still loss if held for 10yrs: 45%. Read more: What is Predictability Rank? Performances of real portfolio Top Ranked Predictable Companies	16.350	219.90	21012.56	0.00	0.00	1.06	0.00	2
Not Rated Top Ranked Predictable Companies	73.490	225.24	2768.38	0.00	-5.90	3.09	0.00	3
Not Rated Top Ranked Predictable Companies	9.950	91.05	5540.42	0.00	0.00	N/A	0.00	4
Not Rated Top Ranked Predictable Companies	13.950	99.04	5540.42	0.00	0.00	N/A	0.00	5
Currently 1/5 Business Predictability Rank: 1-Star Back Testing Results: Average gain of all 1-Star stocks: 1.1% per year. % of Stocks that are in still loss if held for 10yrs: 45%. Read more: What is Predictability Rank? Performances of real portfolio Top Ranked Predictable Companies	34.720	65.81	29633.69	0.00	0.00	1.27	0.00	6
Not Rated Top Ranked Predictable Companies	245.580	905.88	995.10	0.00	0.00	3.40	0.00	7
Not Rated Top Ranked Predictable Companies	195.250	45.89	5377.83	0.00	0.00	N/A	0.00	8
Not Rated Top Ranked Predictable Companies	28.840	112.41	960.88	0.00	0.00	N/A	0.00	9
Currently 1/5 Business Predictability Rank: 1-Star Back Testing Results: Average gain of all 1-Star stocks: 1.1% per year. % of Stocks that are in still loss if held for 10yrs: 45%. Read more: What is Predictability Rank? Performances of real portfolio Top Ranked Predictable Companies	274.380	37.80	5377.73	0.00	0.00	5.73	1.07	10
Not Rated Top Ranked Predictable Companies	313.680	180.50	1522.93	0.00	0.00	3.95	0.00	11
Not Rated Top Ranked Predictable Companies	1459.350	28.10	5404.34	0.00	0.00	5.50	0.00	12
Currently 3/5 Business Predictability Rank: 3-Star Back Testing Results: Average gain of all 3-Star stocks: 8.2% per year. % of Stocks that are in still loss if held for 10yrs: 11%. Read more: What is Predictability Rank? Performances of real portfolio Top Ranked Predictable Companies	347.640	83.01	418.00	19.70	23.00	1.98	11.89	13
Currently 1/5 Business Predictability Rank: 1-Star Back Testing Results: Average gain of all 1-Star stocks: 1.1% per year. % of Stocks that are in still loss if held for 10yrs: 45%. Read more: What is Predictability Rank? Performances of real portfolio Top Ranked Predictable Companies	6.304	106.40	361.78	-7.20	-35.40	N/A	0.00	14
Currently 1/5 Business Predictability Rank: 1-Star Back Testing Results: Average gain of all 1-Star stocks: 1.1% per year. % of Stocks that are in still loss if held for 10yrs: 45%. Read more: What is Predictability Rank? Performances of real portfolio Top Ranked Predictable Companies	3.190	212.92	253.97	0.00	0.00	2.73	0.00	15
Not Rated Top Ranked Predictable Companies	179.800	22.70	609.73	0.00	0.00	15.81	0.00	16
Not Rated Top Ranked Predictable Companies	229.400	54.91	402.73	0.00	0.00	8.76	6.82	17
Currently 1/5 Business Predictability Rank: 1-Star Back Testing Results: Average gain of all 1-Star stocks: 1.1% per year. % of Stocks that are in still loss if held for 10yrs: 45%. Read more: What is Predictability Rank? Performances of real portfolio Top Ranked Predictable Companies	421.060	24.92	2773.70	0.00	0.00	16.73	0.00	18
Currently 1/5 Business Predictability Rank: 1-Star Back Testing Results: Average gain of all 1-Star stocks: 1.1% per year. % of Stocks that are in still loss if held for 10yrs: 45%. Read more: What is Predictability Rank? Performances of real portfolio Top Ranked Predictable Companies	112.870	34.99	571.65	0.00	86.00	12.45	0.00	19
Not Rated Top Ranked Predictable Companies	85.710	19.95	6564.58	0.00	0.00	5.62	13.79	20
Currently 1/5 Business Predictability Rank: 1-Star Back Testing Results: Average gain of all 1-Star stocks: 1.1% per year. % of Stocks that are in still loss if held for 10yrs: 45%. Read more: What is Predictability Rank? Performances of real portfolio Top Ranked Predictable Companies	187.890	44.91	388.04	0.00	0.00	3.44	0.00	21
Not Rated Top Ranked Predictable Companies	800.560	45.27	176.62	0.00	-9.00	N/A	13.86	22
Not Rated Top Ranked Predictable Companies	3222.140	22.49	950.62	0.00	0.00	7.73	0.00	24
Not Rated Top Ranked Predictable Companies	3266.550	22.67	950.62	0.00	0.00	7.67	0.00	23
Not Rated Top Ranked Predictable Companies	164.940	50.02	154.35	0.00	0.00	1.40	0.00	25
Not Rated Top Ranked Predictable Companies	9.730	39.32	183.92	0.00	0.00	3.58	0.00	26
Currently 1/5 Business Predictability Rank: 1-Star Back Testing Results: Average gain of all 1-Star stocks: 1.1% per year. % of Stocks that are in still loss if held for 10yrs: 45%. Read more: What is Predictability Rank? Performances of real portfolio Top Ranked Predictable Companies	12.000	24.47	360.99	0.00	-33.90	6.50	0.00	27
Currently 5/5 Business Predictability Rank: 5-Star Back Testing Results: Average gain of all 5-Star stocks: 12.1% per year. % of Stocks that are in still loss if held for 10yrs: 3%. Read more: What is Predictability Rank? Performances of real portfolio Top Ranked Predictable Companies	3122.880	408.83	93.29	14.70	18.80	24.07	0.00	28
Currently 1/5 Business Predictability Rank: 1-Star Back Testing Results: Average gain of all 1-Star stocks: 1.1% per year. % of Stocks that are in still loss if held for 10yrs: 45%. Read more: What is Predictability Rank? Performances of real portfolio Top Ranked Predictable Companies	268.620	28.60	159.78	0.00	56.10	8.32	2.66	29
Currently 1/5 Business Predictability Rank: 1-Star Back Testing Results: Average gain of all 1-Star stocks: 1.1% per year. % of Stocks that are in still loss if held for 10yrs: 45%. Read more: What is Predictability Rank? Performances of real portfolio Top Ranked Predictable Companies	19.650	19.50	559.60	0.00	0.00	7.28	0.00	30