Joel Greenblatt
Magic Formula
Joel Greenblatt's Magic Formula is a systematic, rank-based approach that identifies companies with high earnings yields (cheap) and high returns on capital (good). Rather than producing a pass/fail verdict, it ranks all stocks and recommends buying the top 20-30, holding for one year, then rebalancing. The approach is designed to be simple enough that anyone can follow it.
Valuation Method
Earnings Power Value
Earnings Power Value (EPV) normalizes current earnings and capitalizes them at the cost of capital. EPV = Adjusted EBIT × (1 - Tax Rate) / Cost of Capital, divided by shares outstanding. Ignores growth to assess value of existing assets.
Checklist (3 Criteria)
| # | Criterion | Metric | Threshold | Data Source |
|---|---|---|---|---|
| 1 | Earnings Yield | EBIT / Enterprise Value | Rank all stocks, best = rank 1 | Income Statement: EBIT; Market Cap + Debt - Cash |
| 2 | Return on Capital | EBIT / (Net Working Capital + Net Fixed Assets) | Rank all stocks, best = rank 1 | Income Statement: EBIT; Balance Sheet: NWC, Net PP&E |
| 3 | Combined Rank | Earnings Yield Rank + ROC Rank | Lowest combined score = best | Derived from criteria #1 and #2 |
Intrinsic Value Method
Earnings Power Value
Normalized EBIT / Cost of CapitalRather than forecasting growth, this method values a company based on its current normalized earning power, discounted by the cost of capital. Conservative by design since it ignores future growth.
Verdict Logic
RANK-based, not pass/fail. Buy the top 20-30 ranked stocks (lowest combined rank). Hold for 1 year, then rebalance. Exclude utilities and financial stocks. Minimum 3-year commitment to the strategy. Market cap floor > $50M.
What Would Joel Greenblatt Buy Today?
Sources
The Little Book That Still Beats the Market
2005 (rev. 2010)Joel Greenblatt
The primary source for the Magic Formula. Explains how combining two simple rankings (earnings yield and return on capital) can systematically identify good companies at bargain prices.