JOEL GREENBLATT - THE LITTLE BOOK THAT BEATS THE MARKET - The Magic Formula.
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Would you like to achieve these percentages, return an average of over 30% per year for 16 years and turn £10,000 into £1,000,000 over the same period!?
In this video we show how Joel Greenblatt did exactly that.
In this animated video we present The Little Book That Still Beats The Market, by Joel Greenblatt.
Joel Greenblatt is an American academic, hedge fund manager, writer and value investor.
Before we look at how Joel Greenblatt achieved such high returns, let’s look at the numbers to see how a £10,000 investment would have grown during the 16 years.
These are the annual returns. The worst year showed a 4% loss and the best year was a return of 79.9%.
The average for the period was 30.8%.
Let’s turn these percentages into an equity curve with a £10,000 starting balance.
We can see that the equity grew to almost £1,000,000. Also notice the exponential growth due to the power of compounding over time.
If the returns from the £10,000 were taken out each year and not reinvested, the profits would only have accrued to £55,000, astonishingly less. Allowing the capital to grow is probably the most important lesson to take from the video.
How did the S and P 500 compare during this period?
A compounded return would have resulted in an end balance of just under £73,000 after 16 years. This is still over a 700% return during the period, but hugely less than the 10,000% return Joel Greenblatt achieved.
He created a value investing strategy called The Magic Formula.
The strategy targets both quality and value stocks using a ranking system. The ranking system comprises of two ratios;
Return On Capital and Earnings yield. These ingredients combined have offered excellent results.
Joel Greenblatt aligns the strategy to his philosophy when he says;
"buying cheap stocks at bargain prices is the secret to making lots of money"
Ok so we have the two ratios that make up the Magic Formula, how do we put these into a single measure to select qualifying stocks?
First, we select the index of stocks for any given major exchange, let’s use the S and P 500 index as an example. We then rank those companies on a scale of 1 to 500 based on their Return On Capital, the company with the highest Return On Capital is placed at the top.
The same companies are then ranked according to their Earnings Yield and again the company returning the highest yield is placed at the top.
Finally, both rankings are combined. In this example we calculate a company ranked number one for Return On Capital but ranked 50th for Earnings Yield. The calculation is simply 1 plus 50 giving a Magic Formula score of 51.