The document discusses the 'magic formula' investment strategy by Joel Greenblatt, emphasizing buying good companies at bargain prices based on key metrics like return on capital and earnings yield. It highlights that historically, this strategy yielded significant returns but has periods of underperformance compared to market averages. The document also provides a step-by-step guide for implementing the magic formula in personal investment portfolios.

1. Using the “Magic Formula” by Larry Holmes

2. Disclaimer This is not personal investment advice or a recommendation to buy or sell any particular security and past performance in not necessarily an indication of future performance

3. Disclaimer All personal investment decisions should be made in the context of your own financial planning goals and tolerance for risk

4. Disclaimer I am not affiliated with Joel Greenblatt or his firm and I don’t benefit financially from the sale of his books

5. The Little Book That Beats The Market by Joel Greenblatt The founder and a managing partner of Gotham Capital Average annual returns of over 40% for over 20 years

6. There’s a crazy guy named Mr. Market

7. “… if you stick to buying good companies … and to buying those companies only at bargain prices … you can end up systematically buying many of the good companies that crazy Mr. Market has decided to literally give away.” -- The Little Book That Beats The Market (p. 45)

8. Question: What’s a good business?

9. Question: What’s a good business? Answer: One with a high return on capital

10. Question: What’s a bargain price?

11. Question: What’s a bargain price? Answer: A business with a high earnings yield

12. Okay, so what’s the Magic Formula?

13. Return on Capital EBIT / (Net Working Capital + Net Fixed Assets)

14. Earnings Yield EBIT / Enterprise Value

15. “… what would happen if we decided to only buy shares in good businesses (ones with high returns on capital) but only when they were available at bargain prices (priced to give us a high earnings yield)?”

16. “ What would happen? Well, I’ll tell you what would happen… We would make a lot of money!” -- The Little Book That Beats The Market (p. 51)

17. From 1988-2004, “owning a portfolio of approximately 30 stocks that had the best combination of a high return on capital and a high earnings yield would have returned approximately 30.8 percent per year.” -- The Little Book That Beats The Market (p. 52) Note: The S&P 500 index returned 12.4 percent per year

18. Question: Why will the Magic Formula continue to work after everybody knows about it?

19. Question: Why will the Magic Formula continue to work after everybody knows about it? Answer: Because it doesn’t always work

20. “ The magic formula portfolio fared poorly to the market averages in 5 out of every 12 months tested.”

21. “ For full-year periods, the magic formula failed to beat the market averages once every four years.”

22. “ For one out of every six periods tested, the magic formula did poorly for more than two year in a row.”

23. “ During those wonderful 17 years for the magic formula, there were even some periods when the formula did worse than the overall market for three years in a row!” -- The Little Book That Beats The Market (p. 70)

24. Step 1

25. Step 2 magicformulainvesting.com

26. Step 3 Follow the instructions to get a list of the best businesses selling at a bargain price

29. Step 4 Buy five to seven of the top-ranked companies Note: Smaller accounts may want to use brokers like foliofn.com

30. Step 5 Repeat Step 4 every two to three months. After nine or ten months you should have a portfolio of 20 to 30 stocks

31. Step 6 Sell each stock after holding it for one year. Use the proceeds to buy more Magic Formula stocks according to Step 4

32. Step 7 Continue the process for many years Note: Don’t even think about evaluating performance for at least three to five years

33. Step 8 Send Joel Greenblatt a note and say thank you!