Magic Formula Joel Greenblatt

Take the following steps to best approximate the results of the magic formula: 1. Use Return on Assets (ROA) as a screening criterion. Set the minimum ROA at 25%. (This will take the place of return on capital from the magic formula study.) 2. From the resulting group of high ROA stocks, screen for those stocks with the lowest Price/Earn- ing (P/E) ratios. (This will take the place of earnings yield from the magic formula study.) 3. Eliminate all utilities and financial stocks (i.e., mutual funds, banks and insurance companies) from the list. 4. Eliminate all foreign companies from the list. 5. If a stock has a very low P/E ratio, say 5 or less, that may indicate that the previous year or the data being used are unusual in some way. You may want to eliminate these stocks from your list. You may also want to eliminate any company that has announced earnings in the last week. (This should help minimize the incidence of incorrect or untimely data.) 6. Buy five to seven top-ranked companies. To start, invest only 20 to 33 percent of the money you intend to invest during the first year. 7. Repeat Step 6 every two to three months until you have invested all of the money you have chosen to allocate to your magic formula portfolio. After 9 or 10 months, this should result in a portfolio of 20 to 30 stocks (e.g., seven stocks every three months, five or six stocks every two months). 8. 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.

by Ramraj