The Magic Formula was defined in the excellent book by Joel Greenblatt called “The little book that still beats the market.”
The formula identifies good quality companies that are trading at an attractive price.
It does this by looking for companies with a high earnings yield (companies are undervalued) and a high return on invested capital (ROIC) (quality companies).
The formula then ranks the universe of companies on ROIC (where 1 is the company with the highest ROC), and by earnings yield (where 1 is the company with the highest earnings yield), and then sum the two ranks to give a combined score.
Companies with the lowest combined rank are recommended for purchase, usually the top 30 companies.
Return on invested capital (ROIC) = EBIT/(net working capital + net fixed assets).
Earnings yield = EBIT / Enterprise value.
You can read more about the Magic Formula here: Magic Formula back test
You may also want to take a look at this article: 15 Magic Formula investment ideas in Europe
Magic Formula alternative?
Here is an article that will interest you: A better alternative to the Magic Formula?
Neither Mr Greenblatt nor the website (magicformulainvesting.com) has endorsed this website or has had anything to do with it. We make our own calculations and we use our own database.