The author Joel Greenblatt returned an astounding 40% per year compounded during a 20-year period from 1985-2005, the greatest publicly recorded return for a large fund. If I could get even half of that over a 20-year period, that would be golden. Consequently, let’s study one of the books he published, you can be a stock market genius, and see if the strategies involved can be replicated.
Joel greenblatt: values all S&P 500 stocks on a daily basis. Buying companies with high valuations (over 50 P/E, since they price at future projected earnings) or non-profitable companies traditionally usually loses money (some make it big)
-he does not look at low price/book or price/sales, he looks at cash flow
-earnings yield: EPS/share price (%)
-buy companies with high ROIC, ROA (min 25%), ROE, and high earnings yield
-99% when he buys, the stock is not at the lowest point (thus, don’t try and time)
-the magic formula works over the long run, but for short periods anywhere it can underperform for a number of years
-a hybrid ranking system that considers both ROIC and earnings yield in aggregate
-also believes efficient market hypothesis is wrong and falsely guides investors as there plenty of under and overpriced businesses
-US markets in the long run will revert to actual values (short term they will be dictated by speculation). For most situations, 2-3 years time is enough time
-recommends 10 to 30 stocks in different industries (lower if actually know something about evaluating businesses)
-reconsider classic value companies like Boeing and CN rail using high earnings yield and ROIC
-you don’t need diversification if you know what you are doing
Www.magicformulainvesting.com
-in reality, time and effort in the stock market investing isn’t a very productive use of time
-95% of stock trading is unnecessary
-MBA skills have limited value. Use investments and good fortune to make a difference in areas that are actually important and that have meaning
-20 to 30 stocks, holding period of a year
-working capital and fixed assets are needed for a business typically
-the formula looks at out of favour companies that are facing headwinds and difficulty
-classic value works everywhere: low P/E, low P/B, low P/S, low price/cash flow, and/or price/dividend. Value oriented strategies consistently outperform in the long run, and more so with small and medium cap companies. More mid pricing occurs for less covered companies (even though it happens in large caps as well). The magic formula works better for larger stocks however (>1 billion)
-1. Return on capital: EBIT/tangible capital employed
Where tangible capital employed= net working capital + net fixed assets
-2. Earnings yield= EBIT/enterprise value
Enterprise value to include debt
EBIT to put different companies with different levels of debt and tax rate on same playing field
EBIT and EV is not skewed by debt and tax, though P/E and EPS is
-let’s say earnings yield of at least 7% to start. Inverse of P/E ratio (net income/market cap) or, EPS diluted/share price
-earnings yield easiest formula: 1/PE of stock
Graham – buy a stock that limits losses in the following condition is met: P/E ratio < earnings yield + growth rate
Peter Lynch even more conservative: earnings growth rate was greater than or equal to P/E ratio
Disclaimer
This is not Financial Advice. This article is meant only for educational and perhaps entertainment purposes.