# Magic Formula investing & Price Index 6m

The Magic Formula investment strategy was developed by Joel Greenblatt and described in his excellent book called The Little Book that Beats the Market.

It is also the book that got me started with quantitative investing.

** **

**What the Magic Formula does**

The Magic 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 that are undervalued) and a **high return on invested capita**l (ROIC) (quality companies).

The formula then ranks the universe of companies on ROIC (where 1 is the company with the highest ROIC), 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.

The screener does all this for you with the click of a button.

Companies with the lowest combined rank (high quality companies that are undervalued) are recommended for purchase, usually the top 30 companies.

** **

**This is how the two Magic Formula investing ratios are calculated:**

**Return on invested capital (ROIC)** = EBIT / (net working capital + net fixed assets).

**Earnings yield** = EBIT / Enterprise value.

** **

**What returns does the Magic Formula generate?**

We tested the Magic Formula investing strategy in Europe over the 12 year period from June 1999 to June 2011.

*Source: Quantitative Value Investing in Europe: What works for achieving alpha*

As you can see companies with the best Magic Formula rank (the most undervalued companies), quintile 1 (Q1) in the above table, did a lot better than companies with the worse Magic Formula rank, and did this for small, medium and large companies.

**Substantially better than the market**

The best Magic Formula investing companies all substantially outperformed the market which returned only 30.54% over the same 12 year period.

** **

**You can improve the returns of the Magic Formula strategy**

We also tested the Magic Formula investing strategy with a lot of other ratios and as you can see in the table below the returns of the strategy can be improved substantially.

*Source: Quantitative Value Investing in Europe: What works for achieving alpha*

In the table the returns you should look at are those in column Q1.

They show the returns generated by first selecting the best Magic Formula investing companies (most undervalued) and then sorting them by the items in the Factor 2 column.

**Best combination +783% was Momentum**

This means you could have earned the highest return of 783.3% over 12 years if you invested in the best ranked Magic Formula companies that also had the highest 6 month price index (price momentum).

**PS** To find Magic Formula investment ideas in the countries you invest in (for less than an inexpensive lunch for two) click here: Join today

**These Magic Formula articles may also interest you:**

Does the Magic Formula also work in Finland?

Does the Magic Formula also work in Belgium, Luxembourg and the Netherlands?

A better alternative to the Magic Formula?

How to get the best returns with Magic Formula investing

**Please note:** This website is not associated with Joel Greenblatt and MagicFormulaInvesting.com in any way. Neither Mr Greenblatt nor MagicFormulaInvesting.com has endorsed this website's investment advice, strategy, or products. Investment recommendations on this website are not chosen by Mr. Greenblatt, nor are they based on Mr Greenblatt's proprietary investment model, and are not chosen by MagicFormulaInvesting.com. Magic Formula® is a registered trademark of MagicFormulaInvesting.com, which has no connection to this website.

**Period**

May 1999 - May 2011

**Index**

+2.25% pa

**Return**

+19.9% pa +783.3% 12yr