30 Stocks from the Magic Formula Screen

In Joel Greenblatt’s 2006 book, The Little Blue Book that Beats the Market, he presented his “Magic Formula” used in his hedge fund, Gotham Capital. Mr Greenblatt tested his formula between 1988 and 2004. The results were incredible - with only one down year, the magic portfolio would have returned 30.8% a year, against a 12.4% annual return for the S&P 500.

Mr. Greenblatt was a student of both Ben Graham and Warren Buffet and tried to include valuable insights from each investor in his “Magic Formula.” His Magic Formula was a screen that percentile ranked two variables: Return on Invested Capital (quality) and Earnings Yield (valuation). The idea is simple, buy the best companies at the best price. He also recommends one year holding periods, so we thought this would be a great time to get this list out. The Little Blue Book recommends selecting the top 30 firms from the “Magic Formula.” That formula ranks each company by variable and then puts a 50% weight on each. Below is a definition of each variable.

Variable 1: Return on Invested Capital = EBIT / (Net Working Capital + Net Fixed assets)

Variable 2: Earnings Yield = EBIT/EV

The table below shows the top 30 firms with reach’s market implied sales growth expectation.

(Source: ValueExpectations.com)

Comments

[Alan Brochs...:]

I read the book and really liked it, even enough to give it to some of my clients. With that said, it is a strategy that works in a mean-reverting environment. Unfortunately, one has to question how it will work in this type of economic environment of a massive shake-out. I would tread very cautiously, as margins, PEs and returns on capital are all highly unknown. To rely upon recent history is to assume that the massive changes in credit availability and usage won't impact the economy, which is rather foolish in my opinion.

Jan 14 09:12 AM

[gebby:]

why is it that investors are not confident in a credit recovery? seems as though analysts are accepting p e of only 5 times earnings as price targets.

Jan 14 10:31 AM

[TraderMom:]

NO Love for the bulls For Now. looking for a solid long entry from here

Jan 20 10:12 PM