Joel Greenblatt’s core investment philosophy centers on value investing: buying quality companies at attractive prices using a systematic, rules-based approach.
• He aims to remove emotion and guesswork from investing by relying on quantitative metrics rather than subjective judgment.
The Magic Formula
• The strategy ranks stocks based on two key criteria:
• High earnings yield (undervalued stocks): Calculated as EBIT (Earnings Before Interest and Taxes) divided by enterprise value.
• High return on capital (quality companies): Calculated as EBIT divided by (Net Fixed Assets + Working Capital).
• Companies are ranked for both metrics, and the best-ranked (lowest combined rank) are selected for investment.
Implementation
• Excludes small-cap, financial, utility, and foreign companies.
• Invests in 20–30 top-ranked companies, rebalancing annually and holding for at least 5–10 years.
• Sells losers before one year (for tax loss harvesting) and winners after one year (for long-term capital gains benefits).
Philosophy in Practice
• Greenblatt’s approach is rooted in classic value investing, emphasizing discipline, simplicity, and long-term consistency.
• The goal: systematically buy good companies at bargain prices, minimizing emotional biases and maximizing returns