How to Beat the Stock Market - Formula Investing

Joel Greenblatt, investor, professor at the Columbia Business School and founder of Gotham Capital, a hedge fund firm, wrote his best-selling investing book The Little Book That Beats the Market (Little Books. Big Profits) back in 2005 with the intention of teaching novice investors how to beat the markets. Greenblatt says of the book that he wanted to tell investors how to make money in terms that his kids could understand : "I figured if I could teach them how to make money for themselves, then I would be giving them a great gift."

Joel Greenblatt says he has developed a formula that will let you beat the stock market provided you have the faith and the patience to stick with it. If you have ever tried online trading then you know that it is not easy and any formula that can beat the market would be worth its weight in dividends! Greenblatt's formula is not unlike the "Warren Buffett way" i.e. "Invest in good companies when they are cheap."

According to Greenblatt his formula has beaten the market for almost 20 years, from 1988 to 2004, with annual returns of nearly 23% from high-return/low-price stocks.

Using Formula Investing to Beat the Stock Market

The formula investing is very simple "If you just stick to buying good companies (ones that have a high return on capital) and .... 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." and Greenblatt added "In a nutshell, the formula is buying good companies cheaply. A good company is one that earns a well above average return on capital. If you can buy a portfolio of "good" companies at below average prices, you will have a successful investment strategy."

This sounds like excellent returns if you can find the right stocks to invest in. What is even better is that Joel Greenblatt puts up all the information for free on his website Magic Formula Investing you just need to register and you can see which 30 or 50 companies his formula recommends! Joel Greenblatt advises buying a range of 20 or 30 top stocks over one year and that you should turn them over according to a specific schedule and depending on their performance.

This investing formula is long-term if you try to apply it to shorter periods the formula may not work. So you may need to wait up to 5 years to benefit from the effects of the formula.

So What is the Magic Formula for Investing?

I have given a brief explanation of the main points of the 'magic formula' below but to really understand it you will need to read the book or visit the website.

If you can't be bothered putting in the necessary effort then you are in luck as Mr Greenblatt will do the work for you at the other website created by Joel Greenblatt and K. Blake Darcy- Formula Investing - but you will need a minimum of $25k to open an account.

There are six easy steps to the formula

1. Stocks are classified each day using 2 criteria: Earnings Yield and Return on Capital which are used together to draw up a list of top-ranked stocks.
2. Stocks in utilities, financial services and smaller companies, are usually removed as are companies for which the data are incomplete.
3. A portfolio of a minimum of 20 stocks must be bought.
4. The portfolio is held for around 1 year to allow for certain after-tax returns considerations. If there are any losses these should be taken just before the 1 year anniversary, gains on the other hand are taken right after the 1 year anniversary.
5. The whole portfolio is sold after 1 year and a new portfolio is purchased.
6. Data show that if you apply this formula for at least 3 years this will allow it to work correctly irrespective of market fluctuations.

I haven't tried it myself as I don't have the capital to tie up fpr that amount of time (yet) but for investors with the necessary capital and time Joel Greenblatt's formula investing seems to be worth taking a very close look at and according to Herb Greenberg of CBS Marketwatch the book is one he always recommends as a gift for people interested in learning about investing The Little Book That Beats the Market (Little Books. Big Profits) .