Wednesday, May 8, 2013

Book Review: The Little Book That Still Beats the Market

The Little Book That Still Beats the Market (2010) by Joel Greenblatt

This book is a slightly updated version of the author's 2005 book, with a new introduction and afterword. The core idea presented in the book is a "magic formula" for investing, which involves finding stocks that are highly ranked based on a combination of earnings yield and return on invested capital. The rationale behind these criteria is that a high return on invested capital is a sign of good management and a high earnings yield is a sign of a bargain-priced stock. The combination purportedly allows investors to identify well-run companies whose stocks are trading at bargain prices. Backtesting of an investment strategy based on the magic formula revealed that it handily outperformed the broader stock market for many years. It is an interesting approach that might be a useful supplement to one's investing strategy, but it might also give some readers the mistaken impression that successful investing can be achieved simply by applying the magic formula, without regard for other important quantitative and qualitative data about a company.

Note: I read this book in April 2013.


  1. Hello DGM!
    Enjoy your blog. Could you please clarify what is meant by earnings yield?

    Many thanks,

    1. MG: Earnings yield is typically defined as the reciprocal of the P/E ratio (in other words, Earnings/Price). Thus, a high earnings yield would correspond to a low P/E ratio. Greenblatt uses a different definition to account for various accounting issues that may differ between companies: Earnings Yield = EBIT / Enterprise Value

  2. DGM,

    I wonder whether individual investors overanalyze stocks and have too few companies. Individual investors will never have the same knowledge as the the professionals, so it will be difficult to beat them on individual picks.

    I find the formula approach to be an interesting middle ground between index investing and having a few select stocks.

    Invest in as many companies as possible within select parameters to reduce risk though diversification. I wouldn't have the same parameters as Greenblatt, since I am more interested in dividends than capital gains.

    Buy the companies with the lowest price to estimated value at any given time which don't already exceed the desired weighting. I estimate the value based on dividends. Using this ratio, you buy the cheapest stocks possible while getting the dividends that are desired.


    1. Ken: Good comment. As I noted in my review, I think the magic formula (or a similar mechanistic approach) could be a useful supplement to one's investing strategy. Once you run a screen and find the stocks that meet your quantitative criteria, then I think some additional due diligence focused on qualitative criteria can help narrow the output to a select group of stocks that may represent good investments.