How to Use “Magic Formula Investing” to Beat the Market
If you take Indian market investors, which may outperform by following his Magic formula – the process of investing in only good companies to get high return on capital with high yield, on the basis of investment in 30 stocks, Greenblatt’s formula actually beats the S & P 500 in 96% of case studies, average annual returns is 30% and above. This formula is Very quantitative, for long term investment strategy, better outputs with small cap stocks as per market values (>1 billion). Stocks on which your investment is may be risk-free as per this magic formula which is experimental results from last 17 years.
Greenblatt’s stock investment strategy of Value investing: buying stocks which were undelivered, due to investor irrationality stocks get undervalued and fall-out. Value investing on the basis of determining the intrinsic value of the company and buying the stocks of this company at a large discount to their values having a margin of safety to ride out ups and down of market prices against this stocks. If the market is volatile and after a few days market gets stabilized then the stocks is raised its value for the stock to fair value.
Have to understand how to work with share prices:
As “Magic formula” investing in designed to Beat the market and with stand any short term investment for shares price, subject to the wild mood swings. How and why shares price moves around the target and stops loss to minimize the loss or booked profit. Greenblatt is explained about this – who knows and who cares! Keep patience for the long term to get proper output from the investment.
How to beat the market through screen stocks:
The magic formula uses two criteria for investing is as-
1. Earning yield as per earning by per shares, the definition of earnings yield is earning/price only, yes how much you earn as per investment on stocks; calculate the price difference on every share. Greenblatt has definition of earning yield as follows –
2. Earning yield = Earnings before interest and tax deduction (EBIT) / enterprise value, An enterprise price or value is used in the calculation, the enterprise values takes into account the value invested for purchasing of equity but also any debt financing used by the company to get profit. Others are as –
3. Return on capital is on basis of – EBIT / (Net working capital + net fixed Assets), where the net working capital is a cash available to invest for investors or operating the business and fixed assets.
Investors can plane as per “Magic formula” itself, just pick the magic formula stocks as step by step to pick perfect stocks for better return according to formula –
1. Choose the stocks as per minimum market capitalization having greater than $100 million.
2. Exclude all others utility and financial stocks because the difference in a business model that hoes they generating money and their financial statements.
3. Determine the company yield, companies return as per capital invested in the business, Ranking of companies as per market scenarios and else.
4. Make your portfolio balanced on every financial year of closing to keep tracking on own investment.