Magic Formula Investing: Does Greenblatt's Method Work?
Greenblatt's magic formula returned 30% a year on paper. Real investors running it earn a fraction of that. The reason isn't the formula. It's the one button he had to take away.
Greenblatt backtest vs S&P 500, 1988 to 2004
Source: Greenblatt, The Little Book That Beats the Market. Real-world live returns have been weaker.
How to run the formula as a UK investor
| Step | What to do |
|---|---|
| Universe | UK or US listed, market cap above £50m |
| Exclude | Financials and utilities |
| Rank | Earnings yield + return on capital |
| Hold | 20 to 30 positions for 12 months |
| Wrapper | ISA to remove the rebalancing tax drag |
The rules are simple. The discipline to hold through underperformance is the hard part.
Key takeaways
Joel Greenblatt's magic formula investing uses two metrics to pick high-performing stocks.
The strategy ranks companies based on earnings yield and return on capital, aiming for those with the highest combined scores.
While the formula showed strong backtested results, real-world performance has been less impressive due to transaction costs and investor discipline.
Applying the formula to the UK market involves additional challenges, such as a smaller pool of large-cap companies and higher liquidity risks for smaller firms.