1.Rank by return on capital
Compute EBIT divided by tangible capital employed (net working capital plus net fixed assets) for every eligible stock. Rank from highest to lowest.
Definition
What is the Magic Formula?
The Magic Formula is Joel Greenblatt's two-factor stock screen: rank every stock by return on capital, rank again by earnings yield, sum the ranks, and buy the top of the combined list. Published in 2005 in The Little Book That Beats the Market.
Last reviewed:
Short answer
The Magic Formula is a deliberately simple two-factor screen: rank every stock from highest to lowest return on capital (EBIT divided by tangible capital), rank again from highest to lowest earnings yield (EBIT divided by enterprise value), add the two rank numbers, and buy the lowest combined sum. The intent is to own good businesses at cheap prices, with the ranking step removing the need for subjective judgment about which factor matters more.
The four steps of the Magic Formula
Greenblatt published the formula in deliberately executable form. invest-like applies the same procedure daily to every eligible US-listed stock and surfaces the top of the combined ranking through the Greenblatt-Fit Score.
2.Rank by earnings yield
Compute EBIT divided by enterprise value (market cap plus net debt) for every eligible stock. Rank from highest to lowest.
3.Combine the two ranks
Add the two rank numbers for each stock. The lower the combined rank, the better the Magic Formula score. The lowest combined ranks become the buy list.
4.Hold for a year, rotate
Greenblatt's original method buys 20 to 30 stocks, holds for one year for tax efficiency, then rotates into the new top of the combined ranking.
Why the Magic Formula works
Greenblatt's backtest covered 17 years of US data and produced roughly 30 percent annual returns before fees. The formula works because both factors are individually effective in academic literature: high return on capital is a quality factor, high earnings yield is a value factor. Combining them ranks businesses that are simultaneously good and cheap.
invest-like maintains a daily-refreshed Magic Formula ranking and exposes the top picks via the Greenblatt-Fit Score on every verdict page. See /learn/what-is-greenblatt-fit-score/ for how the score is computed.
Related
- Top Greenblatt-fit stocks today - the live Magic Formula combined ranking of US-listed stocks on return on capital and earnings yield.
- Seven-framework methodology hub - how the Magic Formula sits alongside the other six value-investing rubrics invest-like scores every stock against.
See the Magic Formula ranking
The Greenblatt-Fit Score surfaces the current top of the combined ranking on every verdict page.
Educational only. invest-like is not a registered investment adviser; nothing here is personalised investment advice. Always do your own research and consider your individual circumstances.