An equity Magic Formula Screener but first some background on the concept
The Best Ever?
In 1985, Greenblatt started hedge fund Gotham Capital, seeded mostly by former junk bond king Michael Milken. While historical returns aren’t available, annualized returns are speculated to be close to 40% from its inception to 2006. These numbers are eye-popping, to say the least. If accurate, Greenblatt would certainly go down in history as one of the best investors ever, topping Peter Lynch and arguably Warren Buffett.
Greenblatt launched Gotham Asset Management in 2009 and through Gotham Funds manages a suite of investment strategies. In 2012, Greenblatt launched the Gotham Absolute Return, a long/short U.S. value equity fund. As of October 2017, Gotham Absolute Return has annualized at 8.5%, more than doubling the HFRX Equity Hedge Index.
In 2005, Greeblatt published The Little Book that Beats the Market, which has sold more than 300,000 copies. In the book, Greenblatt introduced the “Magic Formula” methodology, a very simple value investing strategy that ranks stocks on just two inputs: return on capital and earnings yield. Greenblatt defines earnings yield as EBIT/enterprise value and return on capital as EBIT/(net fixed assets + working capital). In the back-test presented in the book, the Magic Formula strategy produced annualized returns of 30.8% from 1988 through 2004, trouncing the S&P 500’s 12.4% return over the same period.
Several practitioners and academics have been unable to reproduce the huge returns presented in the book. Most point to the effect that small caps may have had in Greenblatt’s backtest. When market cap thresholds are applied, alternative and just as simple methodologies have yielded superior returns (e.g., profit & value vs. magic formula). However, nearly every study has found that even with market cap thresholds in place, the Magic Formula approach does indeed produce benchmark beating returns–just not to the same degree as Greenblatt’s backtest.