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The Little Book That Beats the Market is one of the most popular books published by Joel Greenblatt, the founder of Gotham Capital. In this New York Times bestselling little book, Greenblatt described his quantitative investment strategy of picking stocks, which is widely known as Magic Formula Investing. Nowadays he is using his strategy to manage money for individual clients, and he has been getting a lot of interest. We actually tested his short track record and determined that Greenblatt’s strategy has true alpha, even when we account for style and risk factors such as size, value, and momentum effects.

Here are the top 20 positions in Joel Greenblatt’s 13F portfolio at the end of third quarter:

Company Name

Ticker

Value

Activity

SPDR S&P 500 ETF TRUST

SPY

21488

-13%

GAMESTOP CORP NEW

GME

8987

1%

DELL INC

DELL

8863

6%

TERADYNE INC

TER

8276

-4%

CISCO SYSTEMS INC

CSCO

8162

21%

K L A TENCOR CORP

KLAC

8099

25%

APOLLO GROUP INC

APOL

7987

26%

NORTHROP GRUMMAN CORP

NOC

7734

156%

I T T EDUCATIONAL SERVICES

ESI

7724

44%

APPLIED MATERIALS INC

AMAT

7397

85%

RAYTHEON CO

RTN

7331

21%

MICROSOFT CORP

MSFT

7253

-10%

MEDICIS PHARMACEUTICAL

MRX

7178

17%

LAM RESH CORP

LRCX

7009

14%

DOLBY LABORATORIES INC

DLB

6852

377%

FOREST LABS INC

FRX

6817

23%

ANALOG DEVICES INC

ADI

6606

191%

NEUSTAR INC

NSR

6367

-6%

VIROPHARMA

VPHM

6151

3%

LORILLARD INC

LO

6099

6%

Greenblatt reduced his portfolio value over the third quarter. Gotham Capital had a portfolio value of $715 million at the end of June and the number became $614 million at the end of September. Though the total portfolio value is lower, the number of positions increased from 575 to 588.

During the third quarter, Greenblatt sold out Joy Global Inc (JOYG), which was a new position opened in the second quarter. The stock returned 37.67% since the end of the third quarter. Greenblatt also sold out $2.5 million Nordstrom Inc (JWN), $2.2 million worth of Brown Forman Corp (BF), $2.1 million Kinetic Concepts Inc (KCI), and $1.9 million worth of Limited Brands Inc (LTD). Most of these stocks underperformed the market since the end of September.

Greenblatt increased his stakes in Northrop Grumman Corp (NOC) over the third quarter. His Gotham Capital reported to own $7.7 million worth of the stock at the end of September, up 93% from $4.0 million at the end of June. NOC returned 8.78% since the end of September, beating the 7.80% of SPY by about 1%. In addition to NOC, Greenblatt also tripled his position in Dolby Laboratories Inc (DLB) to $6.9 million and doubled his position in Analog Devices Inc (ADI) to $6.6 million. DLB returned 11.88% and ADI returned 12.96% since the end of the third quarter, both outperforming the market.

Over the third quarter, Greenblatt opened a new position in Triumph Group Inc (TGI). Gotham initiated a brand new $1.9 million TGI over the third quarter. The stock gained 16.86% so far since September 30, beating the SPY by nine percentage points. Besides LSTZA and TGI, Chicos Fas Inc (CHS), Stec Inc (STEC), and Spectrum Brands Holdings Inc (SPB) are among the stocks Gotham Capital opened new positions in the third quarter.

There are several large cap stocks that satisfy Greenblatt’s magic formula criteria: Dell (DELL), Cisco (CSCO), Applied Materials (AMAT), Microsoft (MSFT), Analog Devices (ADI), and Lorillard (LO). Microsoft has been attracting a lot of hedge fund interest this year. David Einhorn is very bullish about the stock. Seth Klarman initiated a huge position in the stock during the second quarter. Microsoft is also the third most popular stock among hedge funds (see the most popular stocks among hedge funds).

We like Greenblatt because he is not secretive about his investment style. Instead, he shares his strategies and opinions with the public and encourages others to do so. His Magic Formula investment strategy produced back-tested returns of 30.8% annually from 1988 to 2004, more than doubling the 12.4% return of S&P 500 during the period. His actual performance is also beating the market. We believe that by focusing on Greenblatt’s best stock picks, investors will be able to outperform the market in the long term.

Source: Joel Greenblatt's Top Magic Formula Stocks