Joel Greenblatt, one of the most successful hedge fund managers with a spectacular track record, created a very simple and effective formula that can easily be understood by even the most novice investors. He wrote a book about it called 'The little book that beats the market' where he explains the formula in detail. His advice sounds very simple: buy good companies at bargain prices and repeat this process every year.
Not exactly rocket science, but it works. To calculate the magic formula, we rank companies based on ROIC and Earnings Yield and then we rank them again based on the sum of the 2 rankings. A company with a magic formula score of 100 is in 100th position out of the stock universe of your last screen. The score is also displayed as a star rating.
New! The Magic Formula score is now fully dynamic and is calculated on a filtered stock universe using the filters specified in the Filter Menu. The filters taken into account are: countries, markets, industries, market cap, trading value, results age and currency.
If you want to get a better understanding of the components used in the Magic Formula calculation, you can click on the 'details' link on top of the chart. This opens the following screen:
Magic Formula Scorecard
First of all, this screen shows a small introduction to the Magic Formula and a useful link to the little book. It then displays a few visualizations that should help get a better understanding of the score:
- In the top right corner, you can see the same star rating as included in the main report. This star rating is based on a percentile calculation, grouping the (filtered) companies into 100 groups of equal sizes.
- In the middle left section, you can see the formula used to calculate Earnings Yield and ROC. It also shows the values for the selected company.
- On the right, you can see a histogram of each respective ratio. A histogram is a graphical representation of the distribution of data. It is calculated by - after removing the outliers - subtracting the minimum value from the maximum value and then splitting this into 100 buckets with equal intervals. Companies are then assigned to the different buckets, which are represented by bars in the chart. When you hover over a particular bar, a pop-up will display the mean of the bucket and the number of companies it contains. All bars are colored in yellow, except for the bar representing the bucket to which the selected company belongs. This is colored in red.
We think this new scorecard provides a much more intuitive assessment of a company's relative cheapness and quality. And since it uses the screener filters of your last screen, you can play around with these filters in the screener and see the effect on the histograms. This way, you can see the histograms for one or more sectors, countries, or selected company sizes.