THE LITTLE BOOK THAT BEATS THE MARKET (BY JOEL GREENBLATT)


This is a top 5 takeaways video summary of The Little Book That Beats the Market, by Joel Greenblatt, the famous inventor of the magic formula. What should you be doing with all your hard-earned money? You could … Put it under a mattress Lend it to a bank Lend it to a company Or, you could invest it in a company, in the stock market. This is probably the best alternative. The problem is just that most people have no business investing in individual stocks on their own, or, as Joel Greenblatt puts it: “Choosing individual stocks without any idea of what you’re looking for is like running through a dynamite factory with a burning match. You may live, but just still an idiot.” There is a solution though. It’s all too early in the video for me to reveal it, but let’s just say that it rhymes with the bagic mormula. Takeaway number 1: The madness of the markets Think of a company, any company. Oh, that’s a good one. Yeah, Amazon it is. During the last year, you could have bought Amazon for as low as $1377, and as high as $2012, a price difference of about 50%.. Not just that, but the value of the whole company bounced from about a $1 trillion, down to approximately $650 billion, and then back up to $1 trillion again! Well, what’s your point? you may ask. My point is that, Amazon – the business – didn’t shift in value that quickly. The market is simply overreacting to the information that it is presented with. But this all may just be a fluke, maybe you, when I asked you to pick a company, happen to pick an extremely volatile one. All right, then. I’ll give you another shot. Think of a company. What was that? Okay sure. Yeah, Gap should do. During the last year, you could have bought Gap, America’s largest fashion retailer, for as little as $18 per share (actually, that’s the current price) and as high as $31 per share. That’s an even bigger difference, more than 70%! Do you think that Gap sold 70% more clothes ten months ago than they do today? NO! Clearly, at times, the market doesn’t know what it is doing. Takeaway number 2: How much is a business worth? When looking at these fluctuations, it’s fairly simple to tell that the market isn’t always efficient. Sometimes, greed is ruling and prices are too high, and at other times, fear is ruling, and the prices are too low. Suppose that the value of the Amazon (as a business) fluctuated between $1,500 and $1,700 during the last year, while the prices fluctuated between $1,377 and $2,012. If you could state this with any kind of certainty, becoming rich trading Amazon stocks would be a really simple task. Just buy it whenever the price goes way below $1,500. and sell it whenever it goes way above $1,700. The problem is it is not that simple. Let’s take an example. One of your friends owns a shop called “The Swedish Merchant”. It sells only Swedish stuff. The shop made a profit of $100,000 last year. How much would you be willing to pay for it, knowing this? Well, your guess is as good as mine (as long as you guessed somewhere between $500,000 and $2 million). In the stock market, you’re typically provided with more information than this before you ask to determine the price of a business, but the difficulties are the same nonetheless. Firstly, $100,000 is just what The Swedish Merchants earned last year. We must determine if it, after our purchase, will be able to generate more or less than that, in the coming year. Secondly, we must decide how confident we are in that prediction. And thirdly it’s not just about the next year, potentially we could own The Swedish Merchant for a very long time. So we have to estimate (okay, guess), how much the business will earn 5 to 10 years from now as well, in order to be able to set a definite price tag on it. Head over to my summary of The Dhandho Investor for more on this. Takeaway number 3: PE and ROA So far, we’ve concluded that stocks sometimes sell at a discount from their underlying value, but that it’s very difficult to decide WHEN that is happening. So is it hopeless? No, obviously not, because otherwise I would be wasting your time, which is something I would never do. Unless of course, I would make a pointless fill-in clip. Let me present The Swedish Merchant’s most fearsome competitor – “Just Broccoli”. The Swedish Merchant earns $100,000 per year, like I presented before, while Just Broccoli earns $50,000. The price of the businesses is $1 million each. Which one would you rather buy, everything else equal? You would buy The Swedish Merchant, of course. Here, you only pay $10 for every $1 in earnings. In Just Broccoli’s case, you pay $20 for every $1 in earnings. The Swedish Merchant would pay your initial investment back in 10 years, compared to Just Broccoli’s 20 years. In the stock market, the most common way of measuring this, is through the so called price to earnings, or p/e ratio. The p/e ratio is calculated by taking a business current price and dividing it by its earnings. The p/e of The Swedish Merchant is 10, and that of Just Broccoli is 20. This is the first point of this takeaway – you would rather own a business with a low p/e than a high one. Simultaneously, price is not everything. Even buying at a low p/e can result in a disastrous investment. You must also make sure that you buy a good business. This is where return on assets, or ROA, comes into play. Let’s say that building that store of The Swedish Merchant cost $500,000, and the store of Just Broccoli also cost $500,000. Everything else equal, would you rather invest in the company that can build stores with $100,000 in profits, for $500,000, or the company that can build stores with $50,000 in profits, for $500,000? Once again, you would prefer The Swedish Merchant’s business¨. This ratio is referred to as return on assets, or ROA. The higher, the better. It says something about the quality of the business, and with comparable companies, it can often show you which of the companies that possess the best moat, something that Warren Buffett loves to see in his investments. For more on important ratios to consider when making an investment, please see my summary of The Interpretation of Financial Statements, by Benjamin Graham. Takeaway number 4: The magic formula If you stick to buying good companies, or in other words those with a high ROA, while buying these companies at low prices, or in other words when their p/e ratios are low, you will end up buying underpriced businesses. Joel Greenblatt’s even constructed a system that will do just that for you, which he calls “the magic formula”. It’s simply ranking companies according to their combined score in these two regards – the quality and the price of the business. Intuitively, it does make a lot of sense. And when back testing it, it does make a lot of financial sense as well. During the 17 years period that Joel Greenblatt evaluated the magic formula, it outperformed the overall market by about 18%, returning 30.8% per year rather than 12.3% per year. With such a return, $10,000 turned into almost a million in 17 years, as compared to the markets more modest increase to just $70,000. Some of the companies that you’ll invest in using this formula, will turn out to be crappy investments. But the important thing is that ON AVERAGE, it will help you to find true bargains. If you’re not impressed by the results yet, consider what happened when Joel Greenblatt divided companies into ten different groups, ranking them with the formula. As you can see, it’s quite a good predictor. The best group performed better than the second-best, and the second-best perform better than the third-best, and so on. Crazy! Takeaway number five: Step-by-step instructions Here comes a step-by-step instruction on how to invest using the magic formula. But, just remember … “The ideas and strategies presented on this channel should never be used without first assessing your own personal and financial situation, or without consulting a financial professional. Please remember that past performance may not be indicative of future results.” 1. Go to magicformulainvesting.com 2. Choose a company size. 50 million or bigger should do. 3. Follow the instructions on the site to get a list of top-ranked magic formula companies. 4. Buy between five and seven of these companies. Spend 20%-33% of the capital that you intend to invest. 5. Repeat step 4 every two to three months, until all your capital is invested. This should result in a portfolio of about 20 to 30 stocks. 6. Sell the stocks after holding them for a year. For tax purposes, hold the winners a few days longer than a year, and the losers a few days shorter. Repeat step 4 with the money from your selling. 7. Continue the process for many years If you are like me, and you find investing to be a very challenging and stimulating interest, that you don’t want to throw away for some automatic formula (with a name that makes it sound like a scam, by the way), you could use it for screening purposes only. For example, find the top 100 companies according to the magic formula and then pick your favorite 10 out of those. A quick summary: Market prices fluctuate more than underlying business values. It’s difficult to estimate the future earnings of a company, and therefore also what a fair price of that company should be. Most investors have no business doing this. P/E and ROA are two of the most (if not the most) important quantitative factors to consider when buying stocks. According to the magic formula, if you buy stocks with a low P/E and a high ROA, you will outperform the market by a wide margin over time. Go to magicformulainvesting.com and get started! And last but not least .. It is difficult to come up with something that rhymes with magic formula. Cheers!

100 Comments

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  2. Simple, but maybe oversimplified? The greatest company measured by P/E and ROA could be using all of their profit to service debt.

  3. Thank you for your great straightforward videos that help us develop a better understanding of investments and finance.

  4. Thank you for sharing a great video. Quote: How does the Magic Formula stock screener choose stocks? A: First, there is nothing "magical" about the formula. Similar formulas also work quite well. Over the last 30+ years we have seen many studies that demonstrate that "value" strategies-such as buying stocks with low price/earnings (P/E) ratios can outperform the market averages. In the case of the Magic Formula system, we are screening for stocks with low P/E ratios ("cheap stocks") that also achieve high returns on capital ("good companies"). We then make some slight accounting adjustments to these commonly used ratios in order to be more accurate for comparison purposes across various companies.

  5. Great video! I think the magic formula is not complete, it only considers the present (last financials) and not the future. With this approach you would have missed rally stocks like Amazon, for example

  6. Atlast I found a fellow swede in trading! I got a question It's hard to find groups interested in trading forex neither here or sweden, do you have a forum or a website you would recommend ?

  7. Kickass Video, the website to the magic formula does not show prices sinces 7/17 so is a bit out of date are you sure abour that information?

  8. Nice summary. I have Joel Greenblat’s Magic Formula book and after watching your video, the book will go up higher on the reading list. Thanks.

  9. Swedish investor..one more request from your fan from india..a summary of "The most important thing illuminated" by howard marks

  10. Great video as always! Do you follow this strategy yourself? What is your favorite book? I would love to see a video on sector rotation investing books. Thanks and keep going. Atte. a faithful subscriber! P.S. You and AutoVlog are the 2 Swedish ppl I follow on youtube hehe.

  11. Overall a good strategy. But Low PE and high ROE fails if it looks at 1 year data. The ratios must take the data of one business cycle, at least 5-8 yrs average. The danger is the profit is inconsistent year on year and hence PE.

  12. Eg: A company at Rs.7000 market capitalisation whose PE is 9 and ROE is 40% should be good at Rs.4200. But its a wrong price to pay because of one "exceptional income" of Rs.700 crores and hence the price shot from Rs.1200 to Rs.4200. Next year you don't find the "exceptional income" in the balance sheet and the stock will fall to Rs.1500 . The foundation is the profit and it should be consistent. Hence average of 5-8 years profit and data gives correct picture.

  13. There is one amazing book about trading: Reminiscences of a Stock Operator. What is great about this book is that it describes trading in early 1900s. A time before charts, computers and books about fundamental/technical analysis. And yet almost everything applies today. The truths which stays the same in drastically different times are one of most important truths.
    would love to see summary of it on your channel

  14. You have a great and unique way to get the most juice out of these books, congratulations!

    I have one suggestion for you “It’s Not About the Money”
    by BRENT KESSEL

  15. Mr. Swedish investor; love your videos! Really fun to watch. From all the knowledge you have acquired from making these videos I wonder what stocks you personally like and invest in? I researched "gap" from your video for a bit of fun, and it looks like the market has priced it correctly at the moment using a 6% discount rate that Joel Greenblatt recommends (even though the 10Y treas is 2 at moment)… what other stocks do you like?. PM me if you like. Great videos. !

  16. wait whaaat? I went and I had to sign up for that website and it screened the top stocks and then I looked them up and non of them is on up trend they are all creating lower lows. non of them is the companies we know of like Amazon, walmart or Tsla. can you explain?

  17. The stock screener didnt work for me. Is this some sort of scam? No filter other than company size? Took the time, really disappointed.

  18. your channel is so under-rated, all the other investor pages just push their sponsored brokerage sites and try get you to trade A TON instead of the ideas and concepts you talk about. Great channel. Keep it up

  19. I've seen a lot of people saying this no longer works very well. Here's one reference: http://www.magicformulaexperience.com/portfolio-update-7-1-2019/

  20. This is stupid, though authoritively presented, it is a waste of time. The only thing to take away is that stocks momentary values are all psychological and emotional, and all who claim otherwise or devise software or quants…are idiots.

  21. Amazing Video. Love it. Keep making more.

    Question: why sell it as soon as one year. You said keep your winners, what if each one of them is 10% YTD since investment, keep them or sell them? Also, keep winner means sell low performers from total portfolio of magic numbers ?

  22. What about do some reseach, on giving and it will be given to you. From the Bible. I have found many became rich with this ironic yet true law.
    Examples are Mr. BEAST on youtube and also the richest man ever, John Rockefeller

  23. After everything is said and done, you still need the money to be buying these suggested money magic stocks. No, it doesn't come cheap. For the average schlub of a person, you'd still need to work for a living but at least you'll get a better idea as to what to actually invest in. Being a well-off real estate agent is no different. Despite what everyone says and how easy they make it look, you still need to do a lot of research and work behind the fluff. Hopefully, you have a matching personality/alignment to implement and execute such things. Anyways, thanks for sharing.

  24. Interesting read on relevance of Magic Formula nowadays: https://seekingalpha.com/article/4176166-magic-formula-lost-sparkle

  25. Why not use ROE or better yet ROIC instead of ROA? It would give a much better measure of efficiency than a company that has a high return on assets but is very indebted.

  26. Market is the most intelligent entity in a country. Don't try to outsmart it. Just follow its price action and try to ride with it.

  27. Invested in broad index-funds in the roaring 1990's and lost money. How? Index funds were a scam then. Maybe better now, maybe not? Vowed to never index again. Buy only individual stocks. Back then individual stocks had to be bought a hundred shares at a time, lest one incur exorbitant fees? No longer. Trades are free and single shares are allowed. Dividends are managed automatically and traceably. So if a broker wanted to perform flimflammery, presumably they'd get caught? There's no excuse not to buy individual stocks and avoid management fees. (more…)

    Gold stocks (spiders, ETF's, etc.) remain a quagmire of rip-offs and scams. Why? Because their valuation is hidden behind a wall of broker and management fees.

    Stick to individual stocks. Dollar-cost-average, especially now. And remember, the money people want Trump gone, so be careful.

  28. But what’s considered low PE ratio in a time where all companies are buying back stock, etfs are overbought and fed is giving money away

  29. Lets just add that no one in the world had 30% yearly average on the long term, so maybe the magic formula is not that magic. Even Warren Buffet makes only 20%, are you saying that he reads boring bullshit all day just to make 10% less, but he is ignoring Greenblatts wisdom?

  30. It's not that easy. You have to take into account growth prospects. For example, you might think GAP is a good buy but when you take into account it has no growth possibilities and is hammered by Amazon, GAP is going below $10 easily.

  31. The problem is the S&P500 is going to peak out as early as this year and as late as next year. Then it will drop at least 40 percent, possibly 60%. The advice of the Swedish Investor is going to cause you to take a drawdown of 50% just like Buffet did in 2000 and 2008. Not too bright if you ask me.

  32. How do you know he didn’t cherry pick companies to prove his formula works? And if it’s this easy to get massive returns, why doesn’t everyone do it?

  33. Good to know, the magic formula seems legitimate for long term traders, but a day trader has no use for P/E ratios or ROA (ROI)

  34. Thanks for making a 5 minute ad for some garbage. Thumbs down and blocked. I'm sure you have good content but I'm sad this was the first video I saw.

  35. I registered at the magicformaulainvesting.com but never received a activation code. Anyone else wait a long time before getting activation code in email?

  36. BE CAREFUL Recency Bias can fool you….Look at Japans Stock market….30 years later hasn't recovered!!!! GAP will never ever recover STAY AWAY from GAP they are the next ASCENA

  37. Hi, Thank you so much fo the video, it's really inspiring.
    I actually read the book after this video
    Here's a site that takes concepts from the book and makes it easy to implement the strategy.

    https://magicformulainvestingstrategy.com/

  38. The importance of a good manager cannot be over emphasized.for inexperience traders you have to be guided on the market to avoid so many loses .trading is not some game its a profession thanks to Mr PAVIL CONRAD who help out TO shaped me and trade on my behalf he trading pattern ensures winning also he teaches me how to trade the market while i gain weekly investing with his such a trusted man .

  39. Question 1: if a company is still on the list (undervalued and growing) why do you sell it?

    Question 2: why sell losses a few days before 1 year?

  40. The Magic Formula has been debunked for years now…

    #1 after this book was published, he tried to start several money management funds using his strategy and they all failed miserably.
    #2 Joel Greenblatt got rich from selling his books… Not from investing (this should be a clear sign).
    #3 The Magic Formula only worked in the period mentioned in his book.

    at https://weeklystocktip.com we've tested this "magic formula" thoroughly and it just doesn't hold up longterm. The only period it performs well in, is the one mentioned in his book. Outside of that too-small sample size. It simply doesn't work. This is called "time period bias". It's just another sham…

    (I'm not saying everything in his books are wrong or worthless information. But the magic formula itself. DOES NOT WORK) Please do your research before throwing your money away.

  41. Nice vid, I liked the conclusion at the end as well. I’ll def check this out as a screening tool for mah swing plays haha

  42. for my investment decision in stocks i apply the discounted cash flow method in combination with a monte carlo simulation.

  43. the present value of a perpetuity of $100K at 2% risk free rate is 5 million. so a price of $500K would most likely be a bargain. meaning, if the company would only make 10K a year its present value would already be $500K.

  44. Nice vids. I get some odd (totally different) results from the magic formula website compared with screener like Tradingview…

  45. Thank you for this interesting summary. What the summary (and the book?) fails to mention is the role of predicted growth. A high PE ratio is very reasonable if you expect the current earnings to grow quickly in the future. Prioritizing companies with low PE ratio and high ROA will lead you to invest in established, streamlined companies that few investors expect to have increasing earnings in the future. This might also lead to a portfolio that is not well-diversified as it does not include smaller growth-focused companies. For example, you would have completely missed out on Amazon or Google in the early years when most of their value was driven by their expected growth. Unfortunately, this book seems to advocated an oversimplified approach to investing. A more sensible approach can be found in A Random Walk Down Wallstreet by Burton G. Malkiel.

  46. Could you do a video on what other indicators could be combined with the "Magic Formula" so we have a "definitive/clear" (based on X assumptions) result on what are the best stocks?

  47. Great video! Thank you. Just wondering is there an alternative to the magicformulainvesting.com tool for investing outside the USA?

  48. follow these steps, and than comes the FED , raising the interest to 6 % , and all ur stocks fall to pinksheet level.
    congratulations.

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