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	15.350	356.72	21012.56	0.00	0.00	1.00	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	45.040	194.11	12035.90	0.00	0.00	1.00	0.00	2
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	66.360	303.00	3048.57	0.00	0.00	0.01	0.00	3
Not Rated Top Ranked Predictable Companies	82.830	136.16	2768.38	0.00	-5.90	3.48	0.00	4
Not Rated Top Ranked Predictable Companies	252.520	492.90	995.10	0.00	0.00	3.70	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	48.160	43.01	29633.69	0.00	0.00	1.90	0.00	6
Not Rated Top Ranked Predictable Companies	37.720	91.27	961.75	0.00	0.00	5.46	0.00	7
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	323.050	32.56	5467.69	0.00	114.80	5.90	1.04	8
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	367.500	73.33	418.00	19.70	23.00	2.09	4.51	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	395.500	27.03	2773.70	0.00	0.00	15.70	0.00	10
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	167.010	37.70	388.04	0.00	0.00	3.74	0.00	11
Not Rated Top Ranked Predictable Companies	1692.320	20.31	51920.55	0.00	14.50	5.34	1.99	12
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	122.410	29.90	571.65	0.00	86.00	13.51	0.00	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	1676.610	21.60	2994.10	0.00	47.50	5.92	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	90769.900	30.67	565.76	0.00	55.00	7.09	2.66	15
Not Rated Top Ranked Predictable Companies	804.240	28.81	353.55	0.00	-18.60	N/A	12.53	16
Not Rated Top Ranked Predictable Companies	17.320	16.50	70894.74	0.00	-23.70	10.01	0.00	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	13691.100	27.29	174.69	0.00	32.70	34.74	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	14118.960	30.17	174.69	0.00	32.70	34.01	0.40	19
Not Rated Top Ranked Predictable Companies	29.910	135.00	94.52	0.00	0.00	14.60	0.00	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	16.890	35.09	131.24	0.00	17.90	12.26	7.25	21
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	3207.440	15.20	368945.95	0.00	29.40	7.14	2.33	22
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	24.110	19.52	706.33	0.00	21.30	1.71	15.84	23
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	41.690	37.03	104.51	6.00	15.30	13.82	4.15	24
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	1879.880	16.50	817.83	0.00	0.00	8.52	0.00	25
Not Rated Top Ranked Predictable Companies	1297.230	24.11	225.31	0.00	0.00	7.37	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	6189.380	18.97	234.15	0.00	7.80	25.82	0.00	27
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	287.280	38.30	91.50	0.00	22.50	N/A	1.45	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	1669.660	14.05	34102.00	5.10	3.30	7.39	5.28	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	82.340	11.10	5202.76	0.00	34.50	1.80	0.00	30