Magic formula investing is Joel Greenblatt's systematic approach to finding good companies at bargain prices. Described in his book The Little Book That Beats the Market, the strategy uses just two metrics to rank every stock in the market.
The Two Metrics
- Earnings Yield: EBIT / Enterprise Value. Measures how cheap the stock is relative to its earnings. Higher is better.
- Return on Invested Capital (ROIC): EBIT / (Net Working Capital + Net Fixed Assets). Measures how efficiently the company uses its capital. Higher is better.
How It Works
The Magic Formula ranks all stocks by each metric separately, then combines the ranks. Stocks that rank highly on both metrics, meaning they are both cheap and high-quality, rise to the top of the combined list.
Why It Works
Greenblatt argues that the market systematically misprices good companies during temporary setbacks. The Magic Formula exploits this by identifying companies that are:
- Undervalued (high earnings yield): the market is pessimistic
- High quality (high ROIC): the business fundamentals are strong
Which of the two metrics does more of the filtering shifts over time. On the run effective 2026-08-01, the return on capital test was the binding one: it was the sole reason for exclusion in 290 cases, against 58 for the earnings yield test. The rule by rule breakdown for every screen shows how to read that for yourself.
One definition is worth checking before you read any result. Greenblatt defines earnings yield as EBIT over enterprise value, while the metric this screen evaluates tracks the reciprocal of the trailing price to earnings ratio almost exactly. A study of eight value screens on one universe shows the evidence for that and lists which other screens return the same companies as the Magic Formula.
Historical Results
In Greenblatt's original research, the Magic Formula returned approximately 30.8% annually from 1988 to 2004, compared to 12.4% for the S&P 500. While past performance doesn't guarantee future results, the logic behind the formula remains sound.