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Greenblatt Wizardry: A Quantitative Look At The Magic Formula

Ryan Telford profile picture
Ryan Telford


  • Magic Formula investing has outperformed over time.
  • While returns are not as impressive as some single factor value strategies, the Large Cap strategy of the Magic Formula has been a less volatile strategy with improved base rates.
  • The “quality companies on sale” criterion allows investors to invest in some household names.

(Credit: Pixabay.com)

The Magic Formula (MF) is a quantitative investing method devised by famed value investor Joel Greenblatt. Greenblatt outlined the Magic Formula in his 2004 book "The Little Book that Beats the Market." After a few years of market performance, he updated the book in 2010 with updated portfolio performance in "The Little Book that Still Beats the Market."

I have written previously on the Magic Formula, describing the method in detail. In this article I would like to continue that thought, but with my own independent backtesting of this strategy.

The Strategy

The Magic Formula screen essentially ranks stocks on two metrics, low relative cost ("cheap") and high returns on capital ("quality" or "good"). Greenblatt's desire was to combine the investment philosophies of both Benjamin Graham (the "cheap" component) and Warren Buffett (the "quality" component). This screen finds quality firms at a discount, in the true sense of value investing.

Greenblatt created the screening website magicformulainvesting.com to allow investors to screen for these types of stocks.

It is important to note here that the Magic Formula is a "multi-factor" strategy in quantitative investing-speak. In previous articles I have discussed the low EV/EBIT strategy, which ranks stocks on a "single factor," namely the EV/EBIT value. The Magic Formula ranks all stocks in the universe by "cheapness," and by "quality." Each is weighted equally and a composite score allows ranking of all stocks.

This is also a "buy and hold" strategy, where an investor purchases a portfolio of stocks, as specified by the given screen criteria, and holds (1 year is typical). At the end of the period, the portfolio is updated with the new screen results, i.e. sell those no longer appearing on the screen and replace with new issues.

Factor #1: Cheapness

The Benjamin Graham half of this

This article was written by

Ryan Telford profile picture
A reader summed up my approach by referring to me as the "intellectual avenging angel".I am an individual investor who is obsessed with finding opportunities for alpha. I invest exclusively in quantitative strategies, through the use of current and historical data, and by looking at a group of stocks rather than individual securities. Using data to inform investing decisions rather than the narrative of the day can provide a real edge.  I am very passionate about separating the truth from the noise, and uncovering true opportunities that others have missed.I research and develop all of my own alpha generating stock trading strategies using Portfolio123.I invite you to join me on my investing journey, where we will learn about all things quant in the never-ending quest for alpha!Click the “Follow” button above to receive notifications of my new articles!

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

I have no affiliation with Joel Greenblatt or magicformulainvesting.com. I am a user of Portfolio123, and have included affiliate links in the article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (43)

Ryan, have you (or anyone) backtested magic formula and compared to the performance of Greenblatt’s GINDX index plus fund? It seems GINDX is a totally different strategy that’s less volatile but with more modest performance than magic formula. I own GINDX and initially thought I was getting an applied version of magic formula.
Has anyone tried weighting cheapness higher than quality or vice versa, to see if that works even better?
zehua profile picture
In portfolio123.com, you can try whatever you want. I find it interesting that this has not beaten the market since 2016 when it becomes popular. I tried many kinds of factor combinations and weights and have not beaten the market.
joel.schopp profile picture
Tobias Carlisle did this in the Acquirers Multiple. He found that EV/EBIT by itself outperformed Magic Formula. However, it is a bit more complicated than that. I'd suggest reading Greenblatt's Magic Formula book and then reading "The Dao of Capital" which is just a fantastic book.
InvestorsEdge profile picture
@zehua you are absolutely correct - the Magic Formula has shown poor returns since 2009. I've just had an article on it published (here if you want to read it seekingalpha.com/... ).

I found that dropping the number of companies and rebalancing more frequently helped, but adding a quality requirement by using the Piotroski F Score and adding Yield as a ranking factor brought up returns to on par with the market.

I still wouldn't invest in it though...
I did magic formula investing for a number of years and it worked very well. I wasn't disciplined enough to track returns to be able to tell you exactly how well but every year the results were impressive. The key thing I want to point out is regarding the comments on tax: the recommended method from the book is to rebalance annually, selling the losers on day 364, and the winners on day 365 - that gives you an income tax write-off on the losses and a capital gains hit on the winners. So the spread between your marginal income tax rate and your capital gains rate comes into play to magnify the gains. I ran the system using a $50M minimum market cap (getting the list from the magic formula web site generator) so most years at least one company would go completely out of business on a portfolio of 30. But given the tax bridge, volatility within the portfolio is your friend, so it all served to increase the results.
zehua profile picture
11 Aug. 2017
gilesbaker, Could you please tell me roughly the performance of your portfolio from 2014-2017?
Thanks for the article. I recall the 17% returns found in the book were not replicable by backtesters at the time, so it's nice to see that level of returns in your large cap analysis.

For those who don't like rebalancing, I think Greenblatt's own analysis of MF investors was that those who never rebalanced outperformed those that did (over 2 or 3 years?).
Also, I think he suggested that those who tried to pick winners from the list rather than choosing arbitrarily underperformed, so excluding the Herbalifes of the market _might_ lead to underperformance.

MF investing does require patience and tolerance, more than many investors can provide as evidenced by book reviews and investor forums. Also, the MF "performance" of "no losses in any 3-year rolling period" noted in the original book ended during the first 3 or 4 years after publication.

For investors, it seems likely that successful strategies will be those "good enough" for an investor to stick with, not those that greatly outperform on paper or the very long term but are too difficult to tolerate year to year.
Rizzo Jonez profile picture
anlamkuyusu - FYI: Joel recommends in his book staying with the program for at least 3 years.
Rizzo Jonez profile picture
Did it for the past 3 years for fun and it lagged the market every year. I did it in IRA's so the tax was not an issue. I will say it is a fun way to invest because you really don't have to monitor the companies you own and just let it cook. I stayed with the plan in two IRA accounts, one was about 160K and the other 90K. You will see some crazy swings up and down on some stocks that will make you crazy. In a weird way it kind of works but in the end I sold out this past August and went to cash on those two accounts before the election. I had already decided that it wasn't worth it. I didn't lose money, I made money but it didn't give me the performance it claims. My core 17 stock dividend portfolios outperformed it every year. And believe me, buying and selling 25 or 30 stocks from the screen all at one time, is work. You struggle to decide which ones even though its not suppose to matter, but it does. I like Greenblatt, I like his writing but the reality is, he made most of his money in special situation stocks and made big bets. That is how most of these billionaires became billionaires. Buffet, Icahn etc...

I found that if you stick with 10 to 17 companies and invest for the long haul and don't freak out when the market goes down and just hold and buy when you know they are cheaper, you can beat the market over time. People to tend to over diversify and hold all kinds of stocks. If you want market beating returns you can't do that. Not to mention only owning a few stocks allows you to know the company very well over time. Then you don't sell unless it blows up.

Here is my core holdings if you are interested. I've owned them for years and they just perform over time. Sometimes they can give you fits, like GILD and even AAPL. But selling and holding just outperforms. No one wants to except that it seems.


I mix a few of them up in several accounts but only hold 16 or 17 at anyone time in each account. Rebalancing in my taxable account is a pain so I try and do what makes sense to keep my taxes in check. In the IRA's its easy.

There is some boring stuff in there, but boring outperforms and most of that stuff all people need. I like that. You can't beat the market unless the stocks you own beat the market over time, its really just that simple. Over diversifying kills your returns.
Anlam Kuyusu profile picture
I think Greenblatt would say 3 years is not enough of a time for the magic formula.

But given how competitive market indices are, I think it's not worth following these strategies.
George Spritzer, CFA profile picture
Index plus (GINDX) is basically an S&P 500 index fund plus a long/short overlay using the Magic Formula methodology. It has done okay, but still has lagged an S&P 500 index fund, which means the Magic Formula overlay did not add value- it subtracted value.
Anlam Kuyusu profile picture
Thanks for the info, though I think it's fair to give these funds at least 4-5 years and then see what happens.

This just shows how competitive indices are.
Anlam Kuyusu profile picture
I just checked with the recent surge, GINDX has returned about ~%10 from December 2015 to December 2016, whereas S&P 500 has returned ~%5 in the same period.

Since its inception in April 2015, GINDX has returned ~%15, compared to ~%7 of S&P 500.
George Spritzer, CFA profile picture
I wonder if the backtesting is accurately measuring "real world" trading costs and expenses.

Joel Greenblatt's Gotham Capital offers six mutual funds using different versions of Magic Formula investing, but they have lagged an S&P 500 index fund over the last three years.

For example, the "enhanced" version of the strategy is GENIX.

Morningstar gives the 3-year performance at 6.63% versus 9.07% for the S&P 500.
Oracle of NJ profile picture
It doesn't. The strategy forces an annual sale to rebalance of the gainers so the tax friction alone will wipe out gains in a taxable account vs riding an index without selling and compounding the whole investment.

Also as you said his own MF funds have underperformed.
Anlam Kuyusu profile picture
Index plus was doing okay?
Ryan Telford profile picture
Thanks for reading George. What I didn't cover in the article was that there is a 1.5% allowance for transaction costs. Every investor's situation is different of course, so they should consider these costs in their investing.

If you assume a $30k portfolio ($1000 each position), $7 trades, and assuming you rebalance the entire portfolio at the end of the year (60 trades), you are spending $420 on a $30k portfolio, or about 1.4% per year. This % decreases of course with a larger portfolio. Also depends on what an investor pays for trades.
thechazanreview profile picture
Very interesting article. Is there any way that you could put together the "executive summary"? Many thanks, but for me, I need to keep it really simple. Otherwise, I get lost!
Ryan Telford profile picture
No problem, I'll see what I can do for future articles!
joel.schopp profile picture
Good review. I'd be interested to see an analysis of the Sigfried screen from the book "The Dao of Capital" by Mark Spitznagel. In the book Spitznagel claims it outperforms the magic formula. The book is a very good read as well.
The_Hammer profile picture
what criteria or metrics used in siegfried screen?
joel.schopp profile picture
It's worth reading the whole book for context, but quoting from the book:

"Each month I purchase the lowest Faustmann ratio firms among those with recent ROICs above 100 percent (with further screening for size and liquidity), and I turn them over as they eventually fail to meet our criteria (checking each year). (I ignore fishy financial values as well as sectors like banks.)"

In his backtesting using compustat data to 1978 it produces 24.6% annualized returns. This beats (in order of results): S&P 500, Fama-French, Magic Formula, Graham, &Novy Marx.

He calculates ROIC differently than some:
"(ROIC) -- best calculated by dividing a company's EBIT (operating earnings before interest and tax expenses are deducted) by its invested capital (the operating capital required to generate that EBIT)"

What's the Faustmann ratio? There's a lot, but here is the crux:
"a low Fuastmann ratio, meaning a low market capitalization (of common equity) over net worth (or invested capital plus cash minus debt and preferred equity) ratio."
Ryan Telford profile picture
Thanks Joel, I'll check out this book. I've heard of it, but I didn't think it had a quant spin.
Oracle of NJ profile picture
I've followd the Magic Formula for many years. I tried it for about 2 years and bailed (much like the book suggests most would do which is why the formula still works!). I think this strategy is great but the hit on all this is in taxes. While you sell your losers at year end you also sell some or all of your winners with this strategy. That means taking a tax hit.

When you account for the tax hit on the winners the formula might lag behind the benchmark where you can hold it indefinitely free of taking capital gains tax hits. This allows more money to compound over time instead of sending a portion of the net gains to the government.

I would do the Magic Formula ONLY in a retirement account to avoid this. I think in a taxable account the benefits are eliminated. You should see if there is some analysis that proves how much drain taxes are on this strategy and if I'm mathematically correct. That is beyond the tools I have.

A great article and well written. I'm always excited to see how the formula does and new backtesting like this. I have all the Greenblatt books including one that is signed by him!
Ryan Telford profile picture
Thanks for chiming in ISRG. The MF is definitely a long term strategy. Easier said than done!

I agree that this strategy, and others like it, ideally should be within a tax-free account. I don't know if its fair to say that taxes wipes out the benefits of these strategies though. Remember that you will have losers in this portfolio as well, which will negate some of the tax burden on the gains. Everyone's situation is different, tax brackets, country, etc.
Celeritas Investments profile picture
Great insight. Will read the book.
Anlam Kuyusu profile picture
Good article as always...

The fact that a scammer company Herbal Life shows up in this search indicates to me how dangerous it is to invest based purely on a screen. Herbal Life is a Ponzi scheme that scams gullible fools. Bill Ackmann has been trying to take them down for some time.

Call me old fashioned but I'll never invest in a business until I can understand and trust what it is that they do to make money...

Similarly, in Greenblatt's screen, you'll also get many patent trolls like PDL Bio Pharma or MYGN... Since a patent troll needs a little investment (just a lawyer) to generate a lot of cash from lawsuits, ROIC and EV/EBIT values end up being high.

Follow Warren Buffet and understand the business before you invest. If you can't understand it, just pass on the company. Remember you are not buying a piece of paper; you are buying a part of the business.
I thought the FTC said Herbalife was not a Ponzi scheme.
Anlam Kuyusu profile picture
They went to great lengths to imply that it was a pyramid scheme while not using the word pyramid.

See this John Oliver video below. He has snippets from WTC spokesperson:

Ryan Telford profile picture
Thanks for the input as always Anlam.

You bring up a point that often comes along with quant investing. Conventional value investing wisdom tells us to buy good companies. Depending on quant value investing, however, this is not always the case. In the "cigar butt" type strategies (think of Benjamin Graham), you are looking for that last puff of a wet, soggy cigar butt.

In some of these quant strategies, one of the potential areas of return is the company turnaround, or acquisitions, which often comes with a premium. The whole topic of "mean reversion" deserves a more detailed discussion.

Some stocks screened may have a different business model that makes the EV/EBIT (or other criteria) artificially high or low. Still, as you are investing in 20-30 stocks, the idea is that you are looking at the overall performance. Think of the basket of stocks as your "margin of safety". That's not to say that the MF can't be optimized.
Trevor Day profile picture
Great read, thanks for writing!
Thanks for the extensively researched article.
Excellent review. Raises a number of questions in my mind, such as what market conditions resulted in the occasional benchmark outperformance. Also, your review seems to assume a full investment at day 1. Curious what the impact would be of something like dollar cost averaging over 3-5 years, or continuous DCA at some low level.
Your presentation here makes me want to dig further. Thank you!
The Great Pyrenees profile picture
Assuming dollar cost averaging is the same amount for each investment, the returns overall should be the same as you will have bigger winners and losers.. Greenblatt doesn't advise tweaking process e.g. selling winners or losers early or holding longer....

The process is a systematic way of investment as opposed to deep analysis or bringing in emotional factors that generally hurt investors because we aren't preprogrammed to handle volatility very well.
Ryan Telford profile picture
Thanks Scobee. As ROIC mentioned, the Magic Formula, and other value quant "buy and hold" strategies are intended to be left alone over the holding period.

In his book, Greenblatt also speaks about phasing in, if you will. Instead of buying 25 or 30 positions at once, buy 2 per month. Hold each stock for the 12 months. So instead of rebalancing once per year, you rebalance monthly. The data in the article is for the situation where you buy all positions at once.

That said, there are quant strategies that add hedging techniques to these buy and hold strategies. I'll be writing about these in the near future.
The Great Pyrenees profile picture
Greenblatt also recommends many value ETFs for those who don't want to buy and sell on a yearly basis in his "Big Secret" book e.g. VTV, VOE and VBR...

Would be curious to see back tested comparison of say VTV to Magic Formula.

Thanks for great article.
Ryan Telford profile picture
Thanks for reading ROIC. Great comment; VTV has only been available since 2004 so we can't make an apples to apples comparison. That said:


The average annual return since inception has been 7.25%. Before 2008, this fund managed to stay ahead of the S&P500, but since then it has trailed it. Using the Vanguard numbers, max drawdown was about 55%. This is not a comprehensive comparison, but indicative.
These days the Magic Formula is trailing the S&P too, isn't it? Your rolling return charts would suggest so. I realize the chart shows 5 year rolling returns whereas VTV has been around for more than a decade, but the overall point is that if you invested in the magic formula 5 years ago you would be trailing the S&P today, right? I personally have been using the Magic Formula since March of 2013 and, FWIW, I'm currently behind where I'd be if I had put it all in VBR.
Ryan Telford profile picture
You are correct. The trend is clear in the 5 year rolling period graph. Over a longer period the strategy has done well, however not so well in recent years.
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