what is magic formula investing 
magic formula investing refers to a rules based disciplined investing strategy that teaches people a relatively simple and easy to understand method for value investing it relies on quantitative screens of companies and stocks and is designed to beat the stock market s average annual returns using the s p 500 to represent the market return put simply it works by ranking stocks based on their price and returns on capital magic formula investing tells you how to approach value investing from a methodical and unemotional perspective developed by joel greenblatt an investor hedge fund manager and business professor the formula applies to large cap stocks but doesn t include any small or micro cap companies understanding magic formula investingthe magic formula strategy was first described in the 2005 best selling book the little book that beats the market and in the 2010 follow up the little book that still beats the market by investor joel greenblatt greenblatt founder and former fund manager at gotham asset management is a graduate of the wharton school at the university of pennsylvania he is an adjunct professor at columbia university s business school in the book greenblatt outlines two criteria for stock investing stock price and company cost of capital instead of conducting fundamental analysis of companies and stocks investors use greenblatt s online stock screener tool to select the 30 to 50 top ranked companies in which to invest company rankings are based on investors who use the strategy sell the losing stocks before they have held them for one year to take advantage of the income tax provision that allows investors to use losses to offset their gains they sell the winning stocks after the one year mark in order to take advantage of reduced income tax rates on long term capital gains then they start the process all over again as greenblatt stated in a 2006 interview with barron s the magic formula is designed to help investors with buying good companies on average at cheap prices on average using this straightforward non emotional approach investors screen for companies that are good prospects from a value investing perspective magic formula investing only factors in large cap stocks and doesn t include small cap companies requirements for magic formula investingsince greenblatt s magic formula only applies to companies with market capitalizations greater than 50 million it excludes small cap stocks the remainder will all be large companies but excludes financial companies utility companies and non u s companies the following points outline how the formula works according to greenblatt his magic formula investing strategy has generated annual returns of 30 though they differ in their calculation of returns from the strategy a number of independent researchers have found that the magical formula investing approach has appeared to show good results when backtested compared to the s p 500 advantages and disadvantages of magic formula investingthe main advantage of the magic formula method is its simplicity you don t need to be a trained investment specialist or wall street prodigy to invest effectively all it takes is a few simple rules to find a basket of reliable investments it also reduces emotional or irrational decision making however contrary to its name there s nothing magical about the magic formula and it may not always be the best strategy some market tests of the formula have found lower than expected returns possibly due to changing market dynamics or the increased number of investors following greenblatt s method in addition some analysts claim to have improved the method by introducing additional variables such as debt equity ratios or dividend yields simple easy to follow rules suitable for every investor facilitates rational numbers based investing without emotion or stress shows better than market returns in multiple backtests returns do not always match the high figures which greenblatt achieved some analysts believe the method can be improved by introducing new variables or rebalancing more frequently 