A New, Easy Way to Use the Magic Formula
If you read articles by Rising Star Jim Royal, you probably know about the Magic Formula. If you don't (on either account), you probably should. I recently found a new screener (yes, another) that offers all the detailed criteria you need to get into the gritty details of the formula and profit greatly from Joel Greenblatt's wisdom.
The foreword to Greenblatt's The Little Book That Beats the Market states that the best thing about it is that most people won't believe it, and that's probably true. The book details what he calls the Magic Formula, a deceptively simple strategy that from 1988 to 2004 would have returned an average return of 30.8% annually, with only one down year.
Sounds crazy, right? But the formula actually relies on two simple ideas: finding profitable companies, and buying them at low prices.
Here's how it works:
To do this, I used Screener.co, which allows you to screen by all of these criteria -- even the earnings-report filing date -- and also allows screening by P/E excluding extraordinary items, to further weed out anomalies. You can then export the results to a spreadsheet to keep track of them. These are the first seven stocks that the screener came up with, which you'd buy if you started the strategy today:
Company | Return on Assets | P/E (Excluding Extraordinary Items) |
|---|---|---|
Power-One (NAS: PWER) | 31% | 6.16 |
Nanometrics (NAS: NANO) | 29% | 6.32 |
Veeco Instruments (NAS: VECO) | 27% | 6.35 |
The Medicines Company (NAS: MDCO) | 27% | 6.54 |
Rubicon Technologies (NAS: RBCN) | 28% | 7.11 |
ITT Educational Services (NYS: ESI) | 54% | 7.29 |
Aeropostale (NYS: ARO) | 29% | 7.44 |
Source: Screener.co.
There's no guarantee that the Magic Formula will continue to work going forward, but it's certainly a great example of how investing doesn't need to be overly complicated and how simple concepts can still be profitable.
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At the time thisarticle was published Fool contributorJacob Rocheowns calls on Aeropostale but holds no position in any of the other stocks mentioned. Check out his Motley Fool CAPSprofileor follow his articles usingTwitterorRSS. The Motley Fool owns shares of Aeropostale and Power-One. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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