Ever wondered about the magic behind successful investing? How does investing wisely contribute to society? What if the formula to wealth was simple, logical, and grounded in timeless principles? Dive in to explore the magic formula, decode the art of investing, and discover how you can contribute to a better future using your wealth.

The Little Book That Still Beats the Market

Jason is a sixth grader who’s found a clever way to make money at school by selling gum. Each day, he buys packs of gum for 25 cents each and sells individual sticks for 25 cents. This means he makes a $1 profit per pack. Selling four or five packs daily, Jason earns quite a bit for an 11-year-old.

One day, on their way to school, Joel, the author, asked his son Ben to calculate how much Jason could make by the time he graduates high school. Ben quickly figured out that Jason could earn over $4,000 in six years. Intrigued, Joel asked Ben how much he’d pay to own half of Jason's gum business. After some thoughtful calculations, Ben concluded he’d pay $450 for half of Jason’s profits, considering the risks and uncertainties.

This conversation helped Ben and can help us understand the basics of valuing a business. But there’s more to learn about investing.

Saving money is crucial, whether for emergencies or future needs. When Joel was young, he spent all his money on novelties from Johnson Smith, a company selling whoopee cushions and giant weather balloons. Joel learned the hard way that saving money for the future is smarter than blowing it on fleeting fun.

Once you’ve saved some money, say $1,000, you need to invest it wisely. Here are your options:
1. Under the Mattress: Safe but unproductive. Your money doesn’t grow.
2. Bank Savings: Safe and earns interest, but often low returns.
3. Bonds: Lending money to companies or the government. U.S. government bonds are nearly risk-free and currently offer around 6% annual returns.
4. Higher-Risk Bonds: Companies like McDonald’s might offer higher interest rates, but there's a risk of losing your money.

The key takeaway is to ensure your investments earn more than the risk-free rate (around 6% for U.S. government bonds). This principle will guide you in evaluating future investment opportunities.

Can a Sixth Grader's Gum Business Teach You About Smart Investing?

Investing money wisely is more than just keeping it in the bank or lending it to the government. Sure, betting on horse races or dog races involving speedy greyhounds can be thrilling, but Joel learned the hard way that it's not a reliable way to grow wealth. His own dog once chased and collided with a mechanical rabbit, leading to a disqualification and a complete loss of his bet. This madcap experience taught Joel that such gambles are not the best use of money.

So, what about investing in a business? Imagine Jason, who was once just a kid scootering around town, now running a successful chain of gum stores called Jason’s Gum Shops. Jason wants to sell half of his business for $6 million, offering shares at $12 each. As an investor, one can buy shares and own a part of his business, reaping a portion of future earnings. But is it worth the price?

Jason’s business made $1.2 million in net profit last year, which means each $12 share earned $1.20. That translates to a 10% return on investment—better than the 6% yield of a risk-free 10-year U.S. government bond. However, several uncertainties remain: future earnings might vary, and the confidence in those predictions is crucial because investing based on poor estimates is risky.

To invest wisely, one must consider the business's potential earnings and compare the returns to risk-free alternatives. Here are the steps:
1. Owning Shares: Buying a share in a business means owning a portion of its future earnings.
2. Estimating Value: Determining a business’s worth involves predicting future earnings.
3. Comparing Returns: The earnings from your investment must exceed the returns from a risk-free bond.
4. Patience and Analysis: Investing isn’t about guessing; it’s about informed decisions and patience.

In Joel's investing class, he often illustrates stock market volatility by showing how the share prices of companies like General Electric or IBM can swing wildly within a year. These large price ranges often don’t correlate with significant changes in the companies' actual value.

Why does this happen? It’s because the stock market behaves like a crazy partner named Mr. Market, who offers to buy or sell shares at prices that can vary dramatically based on mood swings. As an investor, one has the choice to buy, sell, or do nothing based on Mr. Market’s offers. The key is to buy shares when they are priced well below their true value, ensuring a margin of safety.

Benjamin Graham, a legendary investor, emphasized this margin of safety. By purchasing shares at a significant discount to their estimated value, one protects against errors in valuation and unexpected business downturns.

However, estimating a company’s true value is challenging and involves a lot of guesswork. Despite the expertise of professional investors, the stock market’s frequent irrational behavior offers opportunities for those who understand the concept of value investing.

Mastering the Art of Investing: From Greyhound Gambles to Stock Market Swings

Joel loves movies, and The Karate Kid is one of his favorites. There's a scene where Mr. Miyagi, instead of teaching Daniel karate directly, has him wax cars, paint fences, and sand floors. Daniel gets frustrated, thinking these tasks are pointless. But when Mr. Miyagi starts throwing punches, Daniel realizes these tasks have trained him in defensive moves. This moment of revelation illustrates the concept of "willing suspension of disbelief"—we're ready to believe simple methods can work wonders.

Now, let's relate this to investing. Imagine you're considering buying shares in Jason’s Gum Shops. Last year, his 10 stores earned $1.2 million, with each share priced at $12, giving a 10% earnings yield. Sounds good, right? But what if Jason’s earnings fluctuate? Or what if you could earn a risk-free 6% from a government bond instead?

Here’s where we pivot from focusing on what we can't predict to what we can. If Jason's business earned more, say $2.40 per share, the earnings yield would be 20%. Higher earnings yield means better investment. Similarly, comparing Jason’s business to Jimbo’s Just Broccoli, which earns a meager $10,000 per store compared to Jason’s $200,000, shows that a high return on capital is crucial.

Benjamin Graham, a pioneer in investing, used a simple formula to buy stocks priced so low they were bargains. Although fewer stocks meet his strict criteria today, we can adapt his approach by focusing on businesses with high earnings yields and high returns on capital. This strategy, which Joel calls the "magic formula," involves buying good companies at bargain prices.

Over 17 years, this magic formula would have yielded about 30.8% per year, turning $11,000 into over $1 million, far outpacing the market average of 12.3%. By ranking 3,500 companies based on return on capital and earnings yield, and choosing those with the best combination, we systematically find undervalued, high-quality stocks.

So, like Daniel with his unexpected karate skills, investors can become stock market masters using these simple, commonsense tools. Believing in the magic formula, it becomes clear that it makes perfect sense.

Can the 'Magic Formula' From Karate Kid Make You a Stock Market Millionaire?

Artemus Ward once said, “It ain’t the things we don’t know that get us in trouble; it’s the things we know that ain’t so.” This sentiment captures the essence of our predicament with the so-called "magic formula" for stock picking. The formula promises spectacular returns with minimal effort, but does it really work?

The magic formula ranks 3,500 of the largest companies on U.S. stock exchanges, choosing stocks based on a high return on capital and high earnings yield. But what about the real world? To test its reliability, consider the largest 2,500 and then the largest 1,000 companies. Remarkably, over a 17-year period ending in December 2004, the formula worked exceptionally well, providing annual returns of 23.7% compared to the market’s 12.4%.

Could these results be a fluke? Unlikely. Over 4,500 stock picks were made, demonstrating that luck was not a major factor. However, what if market conditions change and these bargain opportunities disappear?

Much like the British in the Revolutionary War, who stuck to outdated strategies, we must question if our magic formula will remain effective. If everyone starts using it, won’t it lose its edge?

Here’s the kicker: the magic formula doesn’t always work. On average, it underperforms the market five months a year and can lag for entire years. For instance, a best-selling author created a mutual fund based on a successful formula, only to see it underperform significantly in its initial years. Similarly, a friend who runs a successful investment firm faced years of underperformance, losing most of his clients before finally achieving stellar results.

The magic formula’s inconsistency ensures it won’t be universally adopted, preserving its efficacy. Most investors lack the patience to stick with a strategy that underperforms for years. Professional managers, pressured to show short-term results, often abandon it too soon.

This brings us to the key principles of the Magic Formula:
1. Long-Term Success: The magic formula works well over the long term.
2. Short-Term Struggles: It often underperforms for several years in a row.
3. Patience Required: Most investors won’t stick with it through tough times.
4. Belief is Essential: You must believe in the formula and maintain a long-term horizon to benefit.

The magic formula’s true test lies in your ability to stay the course, much like the forefathers did during the Revolutionary War. To reap its rewards, you must believe deeply in its principles, even when the short-term results suggest otherwise.

Decoding the Magic Formula: The Ups and Downs of Stock Picking Strategies

In eighth grade, Joel and his classmates had to memorize an odd phrase, "Vomit under the 3em-spaces and run!" to pass print shop class. This quirky mnemonic helped them remember the bottom row of letters in a typesetting box. While now obsolete thanks to computers, it serves as a reminder of how some foundational principles remain timeless. Unlike print shop, math hasn't changed, and its principles are crucial for understanding investment strategies, like the magic formula that Joel Greenblatt discusses.

The magic formula, designed to identify companies with high returns on capital and high earnings yields, aims to find above-average companies at below-average prices. To grasp why this works, consider Jason's Gum Shops. With each store yielding a 50% return on a $400,000 investment, Jason's business exemplifies a high return on capital. This isn't common; most businesses and people can't find such lucrative opportunities.

Why is this significant? High returns on capital often mean that the company has a competitive edge—a unique product, a strong brand, or an advantageous market position. These companies can reinvest their profits at high rates, leading to substantial growth. For instance, if Jason reinvests $200,000 profits into a new store, he could see earnings grow from $200,000 to $300,000 in a year, a 50% increase. This potential for reinvestment and growth makes high-return companies special.

But what about competition? Won't it erode these high returns? Indeed, capitalism encourages competition, which can drive down returns. However, businesses with sustainable competitive advantages, like strong brands or unique products, can maintain high returns longer, which is why the magic formula targets them.

The magic formula isn't just theoretical. Tested over 17 years, it consistently beat market averages, even during downturns. Over three-year periods, it outperformed 95% of the time and never lost money, proving its resilience and effectiveness.

Yet, investing isn't just about formulas; it's also about patience and understanding market behavior. Enter Mr. Market, the metaphor for stock market fluctuations. In the short term, Mr. Market is emotional and irrational, but over the long run, he's rational and fair. If a stock is undervalued, smart investors, company buybacks, or acquisitions will eventually correct its price.

So, whether you're a cautious investor or a thrill-seeker like Joel, who narrowly avoided a barge while sailing, the key is to stick with strategies that make sense, even when they're temporarily unpopular. The magic formula is one such strategy, blending logic with the timeless principles of investing. And if a quirky reminder is ever needed, just think back to "Vomit under the 3em-spaces and run!"

Can Joel Greenblatt's Magic Formula Beat Mr. Market and Boost Your Investment Returns?

You crave the thrill of picking stocks on your own, even if it means blazing through a dynamite factory with a burning match. Sure, the "magic formula" offers high returns with low risk, but you want to be the stock-picking hero. Here's how you can still use the magic formula to avoid blowing yourself up.

The magic formula looks at two key metrics: high earnings yield (companies that earn a lot relative to their price) and high return on capital (companies that earn a lot compared to what they’ve invested). It uses last year’s earnings, which sounds counterintuitive because future earnings matter more. Yet, this method often finds companies that seem like bargains precisely because their near-term prospects look ugly.

Instead of just using last year’s earnings, try estimating earnings for a "normal" year, one without extraordinary conditions. This way, you can better gauge a company's true value. 

If you’re determined to pick stocks, consider this compromise: start with a list of top-ranked stocks from the magic formula and then pick your favorites. Own at least 10-30 stocks to spread your risk. If you’re confident in your research, owning just five to eight stocks in different industries can be effective.

Even pros struggle with accurate earnings predictions. If you can't do this analysis, you have no business investing in individual stocks. Most people should stick with the magic formula, which works by averaging returns from a portfolio of 20-30 stocks.

On Wall Street, there’s no tooth fairy. Brokers, mutual funds, and even hedge funds often don’t deliver the magical returns you seek. Index funds offer average returns but lack the excitement of beating the market.

After 25 years in investment, Joel has found the real magic lies in the magic formula. It’s simple, logical, and effective if you stick with it. So, are you ready to beat the market? Follow the steps, understand why it works, and start your journey to extraordinary investment returns.

Defying the Magic Formula: A Guide to Successful Stock-Picking for the Adventurous Investor

Imagine this: You've taken care of your family, secured your retirement, and treated yourself to some luxuries. Now what? Let's explore the possibilities without drowning in statistics or complex financial jargon.

Joel Greenblatt touches on the magic formula for investing—though he avoids deep dives into compound interest. Yet, consider this: contributing the maximum to an IRA over six years could grow your account to over $325,000 in 20 years and potentially more than $1.3 million after 30 years with a 15% annual return. The magic formula’s past returns have even surpassed this, but let's stay grounded.

For younger readers, here's a fun exercise: imagine a quarter invested wisely. Over 30 years, at a 25% annual return, that single quarter could grow to over $200. This isn’t just about numbers; it’s about understanding the power of smart investing early on.

But what if you achieve financial success? Investing isn’t just about accumulating wealth; it’s about making a difference. Greenblatt suggests considering the broader impact of your investments. Support causes you're passionate about—whether it’s medical research, aiding the underprivileged, or promoting social justice.

One crucial area to invest in is education. In many U.S. cities, only about half of high school freshmen graduate. This waste of potential is staggering. Imagine channeling your resources into education reforms, supporting schools that yield higher returns on investment by nurturing future entrepreneurs, scientists, and engineers. This is where capitalism can offer insights: redirect resources from failing schools to those that succeed, akin to how businesses close underperforming branches.

Greenblatt's approach to investing, the magic formula, has shown strong past performance. While future results can't be guaranteed, the principles remain sound: diversify your investments, hold stocks for about a year, and gradually build your portfolio. Websites like magicformulainvesting.com can guide you through this process.

In essence, investing wisely isn't just about personal gain. It's about using that gain to foster growth and progress in society. So, if you find yourself fortunate enough to benefit from sound investments, consider how you might give back. By doing so, you not only enrich your life but contribute to a better future for all.

Can Your Wealth Change the World? How Joel Greenblatt Suggests Investing for Impact?

There's a savvy sixth grader who makes money selling gum, making a decent amount for his age. This scenario can be used as a basis to understand the valuation of a business. Saving money is essential, and once saved, it should be invested wisely. There are various investment options, each with its level of safety, productivity, and returns. The aim is to ensure that investments earn more than the risk-free rate. 

Investing isn't just about keeping money in the bank or lending it to the government. While betting on races can be exciting, it isn't a reliable way to grow wealth. Investing in a business, like buying shares and owning a portion of its future earnings, can be more profitable. However, it involves evaluating potential earnings against risk-free alternatives, and it's not about guessing but making informed decisions.

The stock market is unpredictable, with share prices swinging wildly within a year. This is because the stock market behaves like a crazy partner, offering to buy or sell shares at varying prices based on mood swings. The key is to buy shares when they are priced well below their true value, ensuring a margin of safety.

Estimating a company’s true value is challenging and involves a lot of guesswork. Despite the expertise of professional investors, the stock market’s frequent irrational behavior offers opportunities for those who understand the concept of value investing. 

One can use a simple magic formula to buy stocks priced so low they are bargains. This involves focusing on businesses with high earnings yields and high returns on capital. Over 17 years, this formula would have yielded about 30.8% per year, turning $11,000 into over $1 million, far outpacing the market average of 12.3%. 

The magic formula’s true test lies in your ability to stay the course. It requires deep belief in its principles, even when the short-term results suggest otherwise. This formula, designed to identify companies with high returns on capital and high earnings yields, aims to find above-average companies at below-average prices. High returns on capital often mean that the company has a competitive edge—a unique product, a strong brand, or an advantageous market position.

If you’re determined to pick stocks, consider this compromise: start with a list of top-ranked stocks from the magic formula and then pick your favorites. Even pros struggle with accurate earnings predictions. If you can't do this analysis, you have no business investing in individual stocks. Most people should stick with the magic formula, which works by averaging returns from a portfolio of 20-30 stocks.

Investing isn’t just about accumulating wealth; it’s about making a difference. It's about using that gain to foster growth and progress in society. If you find yourself fortunate enough to benefit from sound investments, consider how you might give back. By doing so, you not only enrich your life but contribute to a better future for all.

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The Little Book That Still Beats the Market

Joel Greenblatt

Ever wondered about the magic behind successful investing?

How does investing wisely contribute to society?

What if the formula to wealth was simple, logical, and grounded in timeless principles?

Dive in to explore the magic formula, decode the art of investing, and discover how you can contribute to a better future using your wealth.

Key Ideas

#1