Book Reviews

The Little Book That Beats the Market by Joel Greenblatt

How does one go about investing in the stock market and getting returns (20-30%) that beats the market? “The little book that (still) beats the market” by Joel Greenblatt attempts to answer that question. If you’ve already known the basics of stock investing, you’d probably be able skim through the basics, examples, and side stories in this small book and get right to point of the book, the magic investing formula.

The magic formula is the long-term and disciplined stock investing strategy that ranks the best to the worst publicly traded stocks on the market based on 2 key metrics:

  1. The return on capital, % earning relative to capital the company spends to generate the earning; i.e EBIT/(net working capital + net fix asset) and
  2. The earning yield, earning relative to company valuation or market cap; i.e EBIT/enterprise value. With these two metrics, you can screen stocks for great companies at great prices to invest in.

To implement the strategy, follow the 7 steps below:

Step 1 – Go to magicformulainvesting.com.

Step 2 – Follow the instructions for choosing company size (e.g., companies with market capitalizations over $50 million, or over $200 million, or over $1 billion, etc.). For most individuals, companies with market capitalizations above $50 million or $100 million should be of sufficient size.

Step 3 – Follow the instructions to obtain a list of top-ranked magic formula companies.

Step 4 – Buy five to seven top-ranked companies. To start, invest only 20 to 33 percent of the money you intend to invest during the first year.

Step 5 – Repeat Step 4 every two to three months until you have invested all of the money you have chosen to allocate to your magic formula portfolio. After nine or ten months, this should result in a portfolio of 20 to 30 stocks (e.g., seven stocks every three months, five or six stocks every two months).

Step 6 – Sell each stock after holding it for one year. For taxable accounts, sell winners after holding them a few days more than one year and sell losers after holding them a few days less than one year. Use the proceeds from any sale and any additional investment money to replace the sold companies with an equal number of new magic formula selections (Step 4).

Step 7 – Continue this process for many years. Remember, you must be committed to continuing this process for a minimum of three to five years, regardless of results. Otherwise, you will most likely quit before the magic formula has a chance to work!

If you give it a try, please let me know how it goes in the comments. Happy investing!

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