Joel Greenblatt Has A
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His latest publication The Little Book That Beats the Market, offers advice on how to find good companies that have an endearing quality. They’re cheap. This book is written for a novice or someone who doesn’t patience to evaluate and compare thousands of stocks. Like me for instance.
Value investing boring? Not enough action? Joel Greenblatt earned average annualized returns of at least 30% for over 20 years. His Magic Formula is simple. Now sit down and keep reading.
His Lessons
Joel Greenblatt suggests, as any dutiful value investor would, buy companies that earn lots of money, but only when they’re cheap. We’ll discuss how that’s done in a moment. But believe me, it’s easy.Joel calls this method his Magic Formula. After you find these stocks, you hold them for a year and sell them. The stocks you peg as losers are sold a few days before the year is up and the winners are sold a few days after. When you have enough cash ready, take out the Magic Formula and repeat.
The Magic Formula works, but you have to believe. Ok, let’s light up some incense, assume the down dog position and chant. Just kidding. The reason the Magic Formula may not work for many investors is, they won’t wait for the market to correctly value their stocks. Magic Formula stocks may take months or years to achieve the high returns that beat the market. Financially sound companies with cheap stock prices will rebound. If you're willing to wait, you will prosper.
The Magic Formula
This consists of only two components. You will identify:
The ROC (Return On Capital). This ratio figures out how well a company generates profits based on the investment it has in it's business. The higher the ROC the better. The math goes like this -->
Return on Capital = EBIT (earnings before interest & taxes) / (Net Working Capital + Fixed Assets)
By using EBIT, companies can be compared in a fair manner. This eliminates some of the financial tricks a firm might try to pull. It also allows you to evaluate two firms in totally different industries.
Next up is Earnings Yield. We now can find whcih stocks are the cheapest. This ratio is the inverse of the Price/Earnings ratio (P/E). The lower the number, the cheaper.
Earnings Yield = EBIT / Market Capitalization + Total Debt – Cash
Good news everyone! There are two ways to do all of the above in minutes without lifting a calculator. Find a stock screener, set your favorite price range and volume, then add these parameters:
• Return On Asset (for ROC) and screen for minimum return 25% • In addition screen for lowest P/E
Or…….
Joel Greenblatt has a web site called www.MagicFormulaInvesting.com It does all the work. It even ranks the best stocks for you to purchase. All you have to do is register and purchase the top 20 - 30 stocks over time. Or whatever your budget allows. Fill out form and join his site. Let his computers do the work.
Most companies will be excellent candidates for the Magic Formula portfolio. However some “bad” stocks may sneak in.
The ROC can be artificially inflated due to a one time event like selling a division. You must also look at the company and decide if this firm has sustainable competitive advantages and growth.
When will your undervalued company be properly priced and ready to sell for a profit? When Mr. Market says so.
Benjamin Graham calls the irrational stock market, Mr. Market. One day Acme International may be priced at $25 per share. Three months later it's selling at $50 per share. Did Acme sell twice as many widgets? Or did Mr. Market just decide to change his mind.
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Over the short term, Mr. Market can go a little nuts and charge whatever he wants. Over the long term, Mr. Market will recognize value as the company's inforamtion reaches the institutional buyers and the public. Remember, this may take months or maybe years. It is at that point, you beat Mr. Market.
To review, what are we trying to do here? Buy the stocks of companies that offer a great product or service with foreseeable future demand. They have a competitive advantage so we don't see much erosion to their position in the marketplace.
The Magic Formula finds the best companies that Mr. Market has overlooked and thereby priced relatively low. We buy these great opportunities, hold them and wait for the eventual price increase. And sooner than you can say “Here’s Johnny!”, we sell.
The beauty of this whole thing is Joel Greenblatt offers these opportunities on his web site MagicFormulaInvesting.com As of this writing there was no charge.
Joel Greenblatt has earned returns of over 30% for years. The Magic Formula works. Ya just gotta believe.
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