Joel Greenblatt's Magic Formula

Stock Screening
31

Hi Vishal,

I use Capitaline database. Websites are not 100% reliable so I prefer to calculate ratios and scan the market on my own using Capitaline.

Let me explain the process through a live example for the basket to bought on 1st April 2021.

  1. Create the universe - Download the closing prices and m-cap as on 31st March 2021 along with their Sector classification. Select the Top-500 companies based on their MCap. Now exclude companies belonging to Bank, finance, Power generation and distribution and stock brokers sectors. Also exclude all REITs, DVRs and INVITs. This gave me a universe a of 406 companies.

  2. Now we need Return on Capital (ROC) and Earnings Yield (EY) - for in-depth calculation and rationale would suggest to go through the Appendix in the book.

    2.a. ROC calculation ROC = EBIT / (Net Working capital + Net Fixed asset).
    EBIT → Use Trailing Twelve Months (TTM) and is updated every quarter with a lag of 2 months. As per the current rules, companies are required to report the quarterly results within 45-days after the close of each quarter.
    Net Working capital and Net Fixed Asset → Since these are balance sheet data, update it annually.

    ROC is ranked from High to Low, higher the better. Highest ROC is ranked 1st.

    2.b. Earnings Yield EY = EBIT/Enterprise Value
    This calculation is a twist to what we commonly aware of i.e. inverse of Price/Earnings ratio. Here, EBIT is used as per (2.a) above.
    Enterprise value = Mcap + net-debt
    Mcap of last trading day of the previous month is used (in our example it is of 31March2021)
    Net-debt again this being a balance sheet data, it is updated annually.

EY are ranked from high to low (higher the better). Highest EY company is ranked 1.

  1. Both the above ranks are simply added and sorted from Low to High. Top three stocks are then bought in equal weight on the first trading day of the month.

This three-stock basket is held exactly for one year.

Exit - Losers are exited few days before 12 months, STCG benefits and Winners are sold few days after 12 months, for LTCG benefits.

The whole process is done every month.

Commitment - Treat this as a Stock SIP and commit atleast one year for investment and at least 3 years cycles i.e. 36-months cycle to complete in order to reap the benefits out of it.

Reinvestment - From the 13th month, its ones choice to reinvest the proceeds along with the new instalment.

Hope this helps a bit.

Cheers!

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