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"Magic Formula" investing is based on a simple yet powerful way of searching for undervalued stocks. According to Joel Greenblatt’s The Little Book That Beats The Market, portfolios of stocks selected quantitatively based on MFI criteria have handily outperformed the S&P 500 over the past couple of decades.
Why We Like Magic Formula Investing
Advocated by "super investor" Joel Greenblatt. Greenblatt invented MFI as a do-it-yourself version of the approach he has espoused while amassing one of the most impressive investment track records of all time. While reliable data on Greenblatt's complete track record is not available, some estimates put his annualized returns over the past couple of decades at well north of 20%. From 1985-1994, Greenblatt managed the Gotham Partners hedge fund, reporting annualized returns of 50% (after expenses, before performance fees). Gotham returned all outside capital in January 1995.
Simple. The MFI screen ranks companies based on only two variables: "cheapness" (pre-tax unlevered earnings yield) and "goodness" (return on capital employed). The two rankings are given equal weight in the final compilation of the MFI Top 100. This simple process stands in stark contrast to most quantitative screening methods, which rely on multiple variables and are difficult to replicate.
Makes sense. Few investors would prefer a bad business to a good one, and few would purposely ignore the price they pay for a stock. MFI seeks out good companies that are available at good prices. The result is a list of businesses that offer both a high earnings yield and a relatively high probability that capital reinvested in the business will generate high returns. It makes intuitive sense that such stocks should outperform.
Latest "Magic Formula" Stock Screen Results (based on this year's EPS estimates)
Click here to download the latest screen results, including the key financial metrics used in selecting companies for the "Magic Formula" screen.
Disclosure: No positions.
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