Magic Formula Investing  = Value Investing

Basics
 "The secret of sound investment can be summarized in three words :MARGIN OF SAFETY"
(Benjamin Graham)		 "Our goal is to find an outstanding business at a sensible price, not a mediocre business at a bargain price."
(Warren Buffett)
 

Theory : Magic Formula
The "Magic Investment Formula" represents a simple screening process for determining an investment strategy in stocks, namely "cheap and good companies" with a high earnings yield and a high return on invested capital (ROIC). With this formula and on average- you can save some money for mortgages and other important matters- you will be investing in good companies at a very reasonable price.You are buying good companies, on average, at cheap prices, on average.

The point of departure is a list of 3500 major companies listed on US stock exchanges. The formula then assigns a rank to each company, from 1 to 3500, based on their return on invested capital. The company with the highest ROIC is ranked No. 1, while the company with the lowest ROIC is given the lowest ranking, namely 3500. As a next step, the same procedure is used to determine the ranking based on earnings yield. As a last step, these two rankings are combined for each company on our list. Essentially this procedure finds those companies that have the best combination of those two factors!

Greenblatt then suggests an investment in 30 companies with a high ranking: reasonably priced stocks with a high earnings yield and a high return on capital. He explains the success of his magic formula in his book "The Little Book that Beats the Market", showing that his strategy actually beats the S&P 500 in 96 % of all cases, and that an average annual return of 30.8 % was achieved during the last 17 years.

Formula -Greenblatt (US stocks):

  
  1.  Establish a minimum market capitalization (usually greater than $50 million)
  2.  Exclude utility and financial stocks
  3.  Exclude foreign companies (American Depositary Receipts)
  4.  Determine the company's earnings yield = EBIT / enterprise value.
  5. Determine the company's return on capital = EBIT / (Net fixed assets + working capital)
  6. Rank all companies above the chosen market capitalization by highest earnings yield and highest return on capital (ranking by percentages).
  7.  Invest in 20-30 of the highest ranked companies, accumulating 2 to 3 positions per month over a 12-month period.
  8.  Re-balance portfolio once per year, selling losers one week before the year-mark and winners one week after the year mark.
  9. Continue over long-term (3-5 year) period.
  
How does this formula apply to European stock exchanges?  Read more

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