The Magic Formula was created by Joel Greenblatt and first described in his best-selling book The Little Book That Beats the Market. Greenblatt claimed that this formula achieved an annual return of 23.7 percent over a 17-year period from 1988 to 2004. The overall market achieved a return of 12.3 percent over the same period. Various independent backtesting studies confirmed that the formula beats the market in the US and internationally, though not necessarily by the same margin as presented by Greenblatt.Â
The Magic Formula uses the principles of value investing and combines the investment philosophies of Benjamin Graham and Warren Buffet. Essentially, this strategy seeks to buy good companies at bargain prices.Â
The obvious question you may have is how can the Magic Formula keep working when everyone knows about it? Greenblatt claimed that the formula works well in the long-term, but in the short-term Mr. Market may price stocks based on emotion, thus the formula can underperform the market for several years in a row. Most investors just cannot stick with the strategy long enough for it to work. This creates a great opportunity for investors with a long-term investment horizon. Therefore, this strategy is most suitable for investors with patience and a long-term view.Â
