this is a top five takeaways video
summary of the little book that beats
the market by Joelle Greenblatt the
famous inventor of the magic formula
what should you be doing with all your
hard-earned money you could put it under
a mattress lend it to a bank lend it to
a company or you could invest it in a
company in the stock market this is
probably the best alternative the
problem is just that most people have no
business investing in individual stocks
on their own or as Joelle Greenblatt
puts it choosing individual stocks
without any idea of what you're looking
for it's like running through a dynamite
Factory with a burning match you may
live but just still an idiot there is a
solution though it's all too early in
the video for me to reveal it but let's
just say that it rhymes with the magic
Mamula takeaway number one the madness
of the markets think of a company any
company oh that's a good one
yeah Amazon it is during the last year
you could have bought Amazon for as low
as one thousand three hundred and
seventy seven dollars and as high as two
thousand and twelve dollars a price
difference of about fifty percent not
just that but the value of the whole
company bounced from about a trillion
dollars down to approximately six
hundred and fifty billion dollars and
then back up to a trillion dollars again
well what's your point you may ask my
point is that Amazon the business didn't
shift in value that quickly the market
is simply over reacting to the
information that it is presented with
but this all may just be a fluke maybe
you when I asked you to pick a company
happen to pick an extremely volatile one
all right then I'll give you another
shot
think of a company what was that
okay sure yeah gap should do during the
last year you could have bought Gap
America's largest fashion retailer for
as little as eighteen dollars per share
actually that's the current price and as
high as $31 per share that's an even
bigger difference more than seventy
percent do you think that gap sold 70
percent more clothes ten months ago than
they do today no clearly at times the
market doesn't know what it is doing
takeaway number two how much is a
business worth when looking at these
fluctuations it's fairly simple to tell
that the market isn't always efficient
sometimes greed is ruling and prices are
too high and at other times fear is
ruling and the prices are too low
suppose that the value of the Amazon as
a business fluctuated between one
thousand and five hundred dollars and
one thousand seven hundred dollars
during the last year while the prices
fluctuated between one thousand three
hundred and seventy seven dollars and
two thousand and twelve dollars if you
could state this with any kind of
certainty becoming rich trading Amazon
stocks would be a really simple task
just buy it whenever the price goes way
below $1,500 and sell it whenever it
goes way above $1700 the problem is it
is not that simple let's take an example
one of your friends owns a shop called
the Swedish merchant it sells only
Swedish stuff
the shop made a profit of $100,000 last
year how much would you be willing to
pay for it knowing this well your guess
is as good as mine as long as you
guessed somewhere between $500,000 and
two million dollars in the stock market
you're typically provided with more
information than this before you ask to
determine the price of a business but
the difficulties are the same
nonetheless firstly $100,000 is just
what the Swedish merchants earned last
year we must determine if it's after a
purchase we'll be able to generate more
or less than that in the coming year
secondly we must decide how confident we
are in that prediction and thirdly it's
not just about the next year potentially
we could own the Swedish merchants for a
very long time so we have to estimate ok
guess how much the business will earn 5
to 10 years from now as well in order to
be able to set a definite price tag on
it head over to my summary of the dando
Investor for more on this
take away number three PE and ROA
so far we've concluded that stock
sometimes sell at a discount from their
underlying value but that it's very
difficult to decide when that is
happening so is it hopeless no obviously
not because otherwise I would be wasting
your time which is something I would
never do
unless of course I'll make a point this
feeling clear let me present the Swedish
merchants most fearsome competitor just
broccoli the Swedish merchant earns
$100,000 per year
like I presented before while just
broccoli earns $50,000 the price of the
businesses is 1 million dollars each
which one would you rather buy
everything else equal you would buy the
Swedish merchants of course here you
only pay $10 for every $1 in earnings in
just broccolis case you pay $20 for
every $1 in earnings the Swedish
merchants would pay your initial
investment back in 10 years compared to
just broccolis 20 years in the stock
market
the most common way of measuring this is
through the so called price to earnings
or p/e ratio the p/e ratio is calculated
by taking a business current price and
dividing it by its earnings the p/e of
the Swedish merchant is 10 and that of
just broccoli is 20 this is the first
point of this takeaway you would rather
own a business with a low p/e than a
high one simultaneously price is not
everything even buying at a low p/e can
result in a disastrous investment you
must also make sure that you buy a good
business this is where return on assets
or ROA
comes into play let's say that building
that store over the Swedish merchant
cost $500,000 and the store of just
broccoli also cost $500,000 everything
else equal would you rather invest in
the company that can build stores with
$100,000 in profits for $500,000 or the
company that can build stores with
$50,000 in profits for $500,000
once again you would prefer the Swedish
merchants business this ratio is
referred to as return on assets or ROA
the higher the better it says something
about the quality of the business and
with the comparable companies it can
often show you which of the companies
that possess the best moat something
that Warren Buffett loves to see in his
investments for more on important ratios
to consider when making an investment
please see my summary of the
interpretation of financial statements
by Benjamin Graham take away number 4
the magic formula if you stick to buying
good companies or in other words those
with a high ROA while buying these
companies at low prices or in other
words when their p/e ratios are low you
will end up buying under priced
businesses
Joell Greenblatt's even constructed a
system that will do just that for you
which he calls the magic formula it says
simply ranking companies according to
their combined score in these two
regards the quality and the price of the
business intuitively it does make a lot
of sense and when back testing it it
does make a lot of financial sense as
well during the 17 years period that
Joelle green bat evaluated the magic
formula it outperformed the overall
market by about 18% returning thirty
point eight percent per year rather than
twelve point three percent per year
we're the such a return ten thousand
dollars turned into almost a million in
seventeen years as compared to the
markets more modest increase to just
seventy thousand dollars some of the
companies that use invest in using this
formula will turn out to be crappy
investments but the important thing is
that on average it will help you to find
true bargains if you're not impressed by
the results yet consider what happened
when Joelle green net divided companies
into ten different groups ranking them
with the formula as you can see it's
quite a good predictor the best group
performed better than the second-best
and the second-best perform better than
the third best and so on crazy takeaway
number five step-by-step instructions
here comes a step-by-step instruction on
how to invest using the magic formula
but just remember the ideas instead is
presented on this channel should never
be used without first assessing your own
personal and financial situation or
without consulting a financial
professional
please remember that positive forms may
not be indicative of huge results one go
to magic formula investing calm to
choose a company size 50 million or
bigger should do three follow the
instructions on the site to get a list
of top-ranked magic formula companies
for by between five and seven of these
companies spend twenty to thirty three
percent of the capital that you intend
to invest five repeat step four every
two to three months until all your
capital is invested this should result
in a portfolio of about 20 to 30 stocks
six sell the stocks after holding them
for a year for tax purposes hold the
winners a few days longer than a year
and the losers a few days shorter repeat
step four with the money from your
selling seven continue the process for
many years if you are like me and you
find investing to be a very challenging
and stimulating interest that you don't
want to throw away for some automatic
formula with a name that makes it sound
like a scam by the way you could use it
for screening purposes only for example
find the top 100 companies according to
the magic formula and then pick your
favorite 10 out of those a quick summary
market prices fluctuate more than
underlying business values it's
difficult to estimate the future
earnings of a company and therefore also
what a fair price of that company should
be most investors have no business doing
this
pe and ROA are two of the most if not
the most important quantitative factors
to consider when buying stocks according
to the magic formula if you buy stocks
with a low p/e and a high ROA you will
outperform the market by a wide margin
over time go to magic formula investing
comm and get started and last but not
least it is difficult to come up with
something that rhymes with magic formula
Cheers