what is up everyone I'm rose and welcome back to my channel in this video I'm
going to talk all about the magic formula which is a super powerful
investing strategy that has earned twenty to thirty percent returns over
the last few decades just to give you an idea a 30 percent average annual return
you can turn ten thousand dollars into a million in just 18 years the best part
you don't need to be a stop genius to do this the magic formula is actually a
really simple strategy that anyone can follow and it was described in detail in
this great little book right here the little book that still beats the market
written by Joel Greenblatt so if you're interested in making a 20 to 30 percent
return on your money with the magic formula then keep watching
hey and before we get started have you subscribed to my channel yet it's not
what are you waiting for my channel is all about stock investing for beginners
and you're gonna learn a ton about how to intelligently put your money to work
so make sure to subscribe and hit the notification bell for new videos like
this every week so let's dive straight in first I'll explain what the magic
formula is and how it works then I'm gonna give you some background
info on why it works and finally I'll walk you through how to implement it on
your own the magic formula is a stock investing strategy developed by
superstar hedge fund manager Joel Greenblatt his fund Gotham capital has
an annual track record of 40% returns which is really hard to do basically
Joel Greenblatt is a fucking legend in the investment world he explains
everything you need to know about magic formula investing in his little book the
little book that still beats the market and I'll summarize the key takeaways of
the book for you in this video I've also linked to the book below in the
description so you can check it out for yourself alright the magic formula is a
system that ranks all the publicly traded companies in the u.s. in order of
best investment - worst investment then using this ranking you buy the top 20 to
30 stocks and there's actually no rocket science involved this ranking system
uses just ooh key metric so what are these two
metrics I'll tell you what they are and then I'll explain each one in more
detail the first metric is return on capital and the second metric is
earnings yield return on capital is the percentage of a company's earnings
relative to the capital spent to generate those earnings for example
company a is a store that sells widgets it costs a million dollars of capital to
build the store and hire employees and do all the stuff to get into business
let's say that this store generates annual net profits of $100,000 so
company a has a return on capital of 10% or $100,000 divided by the capital of 1
million on the other hand Company B is a similar store that sells widgets as well
let's say it also costs a million dollars to get the store up and running
but unlike company a Company B generates $500,000 of annual profits that's a
return on capital of 50 percent so which would you rather invest in Company A or
Company B the answer is obviously Company B the higher the return on
capital the better because it means this business knows how to maximize profits
given a fixed amount of resources sure great companies have great products with
the O growth potential all that good stuff but all of those factors are very
subjective and kind of qualitative the only way to know for sure whether a
company is a good investment or not is to look at the numbers and the best
number to look at is return on capital by definition great companies generate
high returns on capital so that's the first metric the magic formula uses to
rank the best stocks the second metric is earnings yield earnings eals compares
a company's earnings to its purchase price for example going back to my
widget examples Company A that earns $100,000 a year and let's say that the
owner is willing to sell you the company for five million is it a good deal well
it depends what is that five million gonna get you if you buy company
you're gonna be entitled to its earnings of $100,000 a year on a purchase price
of five million dollars that's an earnings yield of two percent and on the
other hand let's say that you have the option to buy Company B and it's going
for the same price of five million dollars but as you know Company B has
earnings of five hundred thousand dollars in other words an earnings yield
of ten percent so what's a better deal for you
Company A or Company B the answer is again Company B even though they're both
trading at the same price of five million dollars
Company B is actually a better deal than Company A because you're gonna get more
earnings for the same purchase price in other words more bang for your buck the
higher the earnings yield the better and that is the second metric used by the
magic formula to rank stocks when you screen stocks through these two metrics
you end up with stocks of great companies at bargain prices
that is what investing is all about it's common sense right you don't want to buy
shitty companies you want to buy great companies and you want to buy those
great companies not just that any price but at bargain prices you want the best
of both worlds you want great companies bargain prices and so the magic formula
is a simple systematic way to do just that when used to somatically buy stocks
of above-average companies at below average prices you're bound to do really
well in its book Greenblatt compares how a magic formula investing strategy
performed relative to the S&P 500 over a 21-year period between 1988 and 2009
hopefully it comes out with an updated edition with more recent numbers but you
can still get the idea the magic formula investing strategy generated twenty
three point eight percent over that period compared to the S&P 500's nine
and a half percent that means if you started with $10,000 in 1988 with the
magic formula you'd have eight hundred eighty five thousand dollars by 2009
compared to 67 thousand dollars if you just stuck with the
and p500 amazing right so what's the catch
ah there's always a catch if it was that easy everyone would be doing this and
we'd all be bajillion errors so like anything worth doing the magic formula
works but it's a long-term investing strategy if you're looking to get into
the rich then you're probably not gonna stick with this formula because it takes
at least three to five years to work even though the magic formula
outperforms the market over the long term it might actually underperform the
market for small stretches of time unfortunately most people aren't patient
or confident enough to keep the face at stick with the strategy long enough to
enjoy those amazing 23.8% returns don't be one of those people if you're going
to invest with the magic formula plan to stick with it for at least three years
even if your friends are making more money in sexier stocks like Amazon and
Tesla the key here is patience now I want to touch on why the magic formula
works the average newbie investor has no idea
how to evaluate stocks most investing beginners invest in the hot stocks that
everybody is talking about and they don't really know why it's a good
investment other than the fact that other people are saying it's a good
investment if you buy individual stocks without crunching some numbers and
forming a solid argument for why it's a good investment then you're just
gambling your investing based on hope greed FOMO I mean and all of these
emotions have no place in your investing decisions as Joel Greenblatt says in his
book choosing individual stocks without any idea of what you're looking for is
like running through a dynamite Factory with a burning match you may live but
you're still an idiot but you know what researching individual stocks is a lot
of work that's what Warren Buffett does he reads a ton and he usually only has
about eight to ten high conviction stocks in his portfolio most people
aren't cut out for that that's why most people are advised to diversify their
investments as much as possible with something like an SP 500 index fund but
the magic formula is something in between warren buffett and an SP 500
index fund the formula screens through thousands of stocks and you
buying only the top 30 stocks so it's still very diversified because 30 is
still a high enough number that you're not overly exposed to one stock but it's
not as diversified as an SMP 500 funds which has 500 stocks in it so the magic
formula gives you better results than an S&P 500 index funds because it has
diversification but it's also excluded most of the mediocre stocks personally I
think the magic formula is brilliant because it gives you the best of both
worlds it takes the emotion out of investing
decisions because it's basically purely quantitative just based on these two
metrics but it also doesn't require me to do a ton of research and value
companies all day although I do also invest in individual stocks I invest
about a third of my money using the magic formula because it's a great way
to always have some money working for me in the stock market even when I don't
have any investment ideas of my own hopefully by now you're convinced that
the magic formula is awesome and that you should totally try it now I want to
walk you through how to implement it on your own so here's how it works first
you have to buy 30 magic formula stocks over a period of one year and you spread
it out over the year in order to spread out your int entry points into the stock
market then you hold each stock for one year and then you sell it so the end
result is that you'll always be rotating through 30 stocks in your portfolio and
always selling each stock after a holding period of one year so here's how
to do it step-by-step first you need a brokerage account with money in it this
can be an IRA or a non retirement brokerage account whichever you prefer
ideally it's at a discount brokerage like fidelity or Robin Hood where you
pay little to no trading commissions because you'll be buying a lot of stocks
and the commissions can really add up then step number two is to go to magic
formula investing calm and create an account so you can use their stock
screener this website was developed by Joel Greenblatt specifically to help
magic formula investors implement the strategy so you use the stock screener
to generate a list of the top ranked companies
in the screener I'll just put fifty million dollars as a minimum market cap
but if it makes you more comfortable to invest in larger companies feel free to
use a hundred million dollars or higher after you click get stocks you'll get a
list of the companies that have the highest returns on capital just like we
talked about and the highest earnings yields so these companies have the best
of both worlds and they're all ranked also the magic formula is based on
buying equal dollar amounts of each stock so since the full portfolio has 30
stocks if you have $30,000 total then you'll want to buy $1,000 worth of each
stock after you buy your first five stocks then wait two months and then buy
five more keep doing this every two months and 12 months later you should
have 30 stocks in your portfolio so you bought stocks in batches of 5 and you
did that six times over 12 months if that makes sense after 12 months the
first batch of 5 stocks that you bought has now been in your portfolio for 1
year and remember the magic formula wants you to hold each stock for just
one year so this is where it can get a little bit tricky you have to keep track
of when you bought each stock and make sure you sell it after exactly a holding
period of one year I keep a simple spreadsheet it's not that hard yeah it
does involve a little bit of work but it's definitely a lot less work than
researching individual stocks I don't know about you but if it means I can
make juicy returns of 2030 percents I'm game
because I didn't want this video to turn into an hour-long tutorial I know this
is a pretty brief walkthrough of how to implement but if you're serious about
doing it then definitely check out joel Greenblatt's book for detailed
instructions or if you want to see me do an in-depth tutorial with screencasts
and my spreadsheets and all that then type tutorial in the comments below to
let me know so that's basically with Joel Greenblatt's magic formula is all
about and by now I hope you have an understanding of why it works so well
and why it's a good idea for most people as Joel Greenblatt explains most people
have no business investing in individual stocks on their
own so the magic formula is an easier more accessible way to invest in the
stock market I think the key takeaway here is that
picking great businesses at bargain prices is the absolutely fundamental
concept of smart investing so whether you implement the magic formula or not
you can still use these concepts to make better investing decisions for example
rather than buying the 30 stocks on rotation the way the magic formula wants
you to do you can also maybe use it as a handy stock screener so you can just use
that ranking of 30 stocks as a starting point for stock that you might want to
do more research on did you like this video if so then please give it a thumbs
up and if you have any questions at all about the magic formula feel free to ask
me in the comments or DM me on instagram @ investing with Rose to learn more
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