The little book that beats the market, by Joel Greenblatt


(R3) #1

What are your thoughts on this little book?
The bulk of the book explains how Mr Market work. It does so in a manner that makes things simple to understand.
In the later chapters, Joel Greenblatt introduces what he calls the magic formula. Explains how it works, shows the results achieved by it, compares it with benchmarks. And explains why not many people will ever use it.
Have you read this book?
What do you think of it?
What do you think of the way he explains the way markets work?
What do you think of his magic formula?
Do you use it?

My toddler views:
I’ve read the book and I like it. I’ve read it a couple of months before I’ve read B. Graham’s Intelligent Investor, and I think that helped.
As for the magic formula… I don’t apply it. Why? Because the amounts I’m able to save for investment purposes are too small to justify the costs, i.e. fees. Hence I’ve been indexing.
Meanwhile Freetrade shows up. Fees are no longer an issue.
I can’t say I’ll use JB magic formula for I fear I’m not qualified to provide advice. Neither I’ll say I won’t use it once the Android app is up and running. I won’t stop indexing though. :thinking:


(Ryan) #2

I have heard of this book but never read it.

It sounds similar to advise that Jack Bogle provides, and what he wrote about, that indexing is the best option. I have read Intelligent Investor and Graham goes into detail about ‘Mr Market’.

But I’ve never heard of the ‘magic formula’. Could you elaborate on this please? Also, why does this magic formula not work if you only have small amounts of capital? Interested to find out more!


(Jeff puckering) #3

I think it does, it’s just with anything (other than Freetrade) fee’s make investing small amounts pointless.

@Raul I Would love to hear more about how you have interpreted the strategy too.


(R3) #4

The magic formula ranks companies based on two factors: return on capital and earnings yeld.
With return on capital you get to find good quality companies. With earnings yeld you’ll find attractive prices.
Combine both.
Build a portfolio of 20 to 30 stocks.
Sell each stock after holding it for a year.
Do this for a minimum of 5 years.

It’s not that the formula doesn’t work if you only have small amounts of capital. I simply prefer indexing given the circumstance of being able to allocate small amounts of capital only. I don’t like to pay 10 quid per trade. In a portfolio like the one in the magic formula that means 40 to 60 trades per year: 400 to 600 quid in transaction fees only. That has a massive negative impact on my rate of return. And a positive impact on the broker’s revenue. Hence I’ve been indexing. If I recall correctly JB doesn’t mention indexing in this book.

It’s a couple of hours read. Search online and you will find it.


#5

This is inevitably oversimplifying (and possibly incorrect!), but…

I guess the Bogle’s magic formula is simply being in the market a long time, being very diversified, being very low cost. So you don’t actually need to look at ROC, yield or any of the financial ratios, nor even select a stock, nor sell after X period. Just buy and keep buying something that tracks the index, and start selling it when you start needing the cash.


(R3) #6

Hi rod.
If I’m not mistaken things are like that. For more details on John Bogle, he wrote the book The little book of common sense investing. It talks about indexing. That’s what I’ve been doing.

The magic formula I was talking about is something else. And yes it does imply some homework


(R3) #7

In other words…
Indexing can be called passive investing.
JB magic formula can be called an active investing strategy. It’s not the only one out there, and probably not the best one, but according to the author, reviews made by others, and results presented by some over a few years, it does what it says, i.e. it beats the market


#8

People who are passive/indexy true believers, or who believe that markets are relatively efficient, might find that “it beats the market” assertion a bit suspicious.


(Ryan) #9

Thanks for explaining this.

What is the ROIC you are looking for? I assume it will be >10%, for say the last 5 years?
Similarly, with the earnings yield, what sort of yield does the book mention?

Also ‘sell each stock after holding it for a year’ - what if the stock is currently at a loss? Do you sell at a loss? Also, the whole theory of cutting losses and letting your winners run - what if you sell after 1 year but the stock keeps going higher?

I am currently reading One Up On Wall Street by Peter Lynch, but might give this a read after. Sorry for all the questions, but I’m always interested to find out more about different strategies. Cheers, Raul!


(R3) #10

If anything, the assertion should read:

I repeat:

The book was first published in 2006. It results from a study conducted by the author, a successful investor and a teacher in Columbia. There is a new edition dated from 2015 if I’m not mistaken.
In the book the author explains the methodology employed to conduct the study and shares the results he obtained: 30% annual returns on average during a period of 17 years (1988-2004). 30%. Versus 12.4% for the S&P 500. As my granny would say: that sounds too good to be true, isn’t it?

Acording to https://www.euclidean.com/little-book-that-beats-the-market-review-and-lessons/

Return on Invested Capital (ROIC) = (Earnings Before Interest & Taxes + Depreciation – CapEx) / (Net Working Capital + Net Fixed Assets)

This tells you how much cash a company generates in relation to the amount of capital tied up in its business. As ROIC numbers increase, all else being equal, a business gets better and better. The reason is that when you own a business, the higher your ROIC, the more money you are able to pocket every year in relation to the money you have invested in the business.

Earnings Yield = (Earnings Before Interest & Taxes + Depreciation – CapEx) / Enterprise Value (Market Value + Debt – Cash)

This tells you how expensive a company is in relation to the earnings the company generates. When looking at Earnings Yield, we make certain adjustments to a company’s market capitalization to estimate what it would take to buy the entire company. This involves penalizing companies that have a lot of debt and rewarding others that have a lot of cash.

You can also check:

https://www.gurufocus.com/news/116960/book-review-the-little-book-that-still-beats-the-market-by-joel-greenblatt

Acording to the author:
“Sell each stock after holding it for one year. For taxable
accounts, sell winners after holding them a few days more
than one year and sell losers after holding them a few days
less than one year (as previously described). Use the proceeds from any sale and any additional investment money
to replace the sold companies with an equal number of
new magic formula selections (Step 4).”

Carry on reading One up On Wall Street, and then read Beating the Street also by Peter Lynch. In one of them books Peter Lynch shares with us what he did when that happened to him.

Read The litle book that still beats the market.

Joel Greenblatt says in this book, amongst many other things:

  1. Most people have no business investing in individual
    stocks on their own!
  2. Reread summary point number 1.

It just so happens that he does. I first read it in 2016. I had to fetch it to write this and he does mention it. My bad.

I don’t think I can say much more than this without quoting the whole book. There are so much more to it, like the role of human behavior in changes in price or loss creation.

Do enjoy. Let me know what you think.


#11

Greenblatt is now running several funds at Gotham asset management based on these principles - some are available as ETFs but unfortunately the management fees are prohibitively high


(R3) #12

Other reviews. Some more positive than others:

https://fourminutebooks.com/the-little-book-that-still-beats-the-market-summary/

https://www.quora.com/Investment-Advice-Does-the-Magic-Formula-in-the-The-Little-Book-That-Still-Beats-the-Market-give-20-or-better-average-annualized-returns-over-3+-years


(R3) #13

and

http://www.aei.org/publication/more-evidence-that-its-very-hard-to-beat-the-market-over-time-95-of-financial-professionals-cant-do-it/


(R3) #14

If I understand it correctly current featured funds in Gotham Asset Management don’t follow the magic formula presented in the little book that beats the market. Instead they follow a long-short strategy:

enough said


#15

well they’re running a long/short strategy based on a proprietary value factor - in which ROIC and earnings yield probably play a part.


(R3) #16

Sorry mate. My bad. I don’t question there are shared principles between the strategy presented in the book and the strategy currently employed in funds managed by Gotham where

I’m trying to make it clear that the magic formula is different from the strategy employed in current funds managed by Gotham, for one is long and the other is long-short.
Principles are most likely shared, ROIC and earnings yeld probably play a part in the valuation process, but they are two different things.

What I really like and think is important about this book is not the formula per se. It’s all the rest. The formula may or may not work. What’s important is that the ideas are presented in a way a newbie can understand Mr Market, human behaviour and some of it’s effects on active management, the importance of due diligence, how to valuate a business, etc