To get the good returns he promises, Greenblatt applies a formula that works if you have faith and patience. In many respects Greenblatt's formula is similar to the value investing strategy of Warren Buffett : "Invest in good companies when they are cheap."
Greenblatt claims that his formula has beaten the stock market for nearly twenty years, saying that 1988 to 2004, the high-return/low-price stocks of 30 of the largest 2,500 companies had annual returns of almost 23%.
Sounds good, so how do you find these stocks? Well it is actually quite simple. "If you just stick to buying good companies (ones that have a high return on capital) and to buying those companies only at bargain prices (at prices that give you a high earnings yield), you can achieve investment returns that beat the pants off even the best investment professionals."
What is even more simple is that Joel Grenblatt has a website Magic Formula Investing which finds the stocks for you! You just need to register for free and you get access to his stock picker tool that will select the companies for you.
For individual investors he recommends getting a basket of 20 or 30 top stocks over the course of a year and says that you should turn them over on a strict schedule, depending on performance. There is no mention of any minimum amount you need to invest.
But bear in mind this is long-term investing, over "shorter" periods, often years, the formula may not work. So you may have to wait up to five years. One problem encountered is that if your stocks underperform the market for the first two years then there is the temptation to dump the formula, but Greenblatt says you have got to stick with it.
The book, on the other hand, won't take you five years to read, you can get through it in two hours. It may even be available as an e-book one day ! And you can learn a lot direct from an expert about bonds, stock and shares and prices, return on capital, earnings yields etc....
For those who can't be bothered doing the work Greenblatt has recently launched a website - Formula Investing - where he will do the investing for you if you prefer. You need a minimum of $25,000 to open an account.
On his website he expains that there are six steps to stock market investing success with his formula
- Stocks are ranked daily using 2 criteria: Return on Capital and Earnings Yield which are combined to create a list of top-ranked stocks.
- Stocks in financial services and utilities, and smaller companies, are generally removed along with any company with incomplete data.
- A portfolio of at least 20 stocks is bought.
- The portfolio should be held for approximately 1 year to allow for after-tax returns considerations. Any losses should be taken just before the 1 year anniversary, any gains are taken right after the 1 year anniversary.
- The portfolio should be sold after 1 year and a new portfolio should be purchased.
- Data shows that following this process for a minimum of 3 years appears to allow the system to work correctly irrespective of typical market fluctuations.
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