Imagine a world where you could consistently beat the stock market with a simple, mechanical formula. No complex analysis, no gut-wrenching decisions—just a reliable system that spots winners. This isn’t a fantasy; it’s the tantalizing promise behind the concept of a magic formula investing.
For decades, investors have searched for that holy grail. The appeal is undeniable. Who wouldn’t want a strategy that saves time, reduces stress, and delivers superior returns? This guide will dissect the most famous strategies, update them for today’s market, and give you a practical, actionable plan. You will discover that while no formula is perfect, some come remarkably close. Let’s dive in.
The Genesis of Systematic Investing: Benjamin Graham’s NCAV
The quest for a mechanical edge began with Benjamin Graham, the father of value investing. His most rigorous approach was the Net Current Asset Value (NCAV) method. He advocated buying companies trading for less than two-thirds of their net current asset value. This essentially meant purchasing a dollar for pennies.
Historically, this was a goldmine. In the fragmented markets of the early 20th century, such bargains were more common. However, the landscape has drastically changed. The rise of quantitative hedge funds, activist investors, and private equity firms means these deep-value stocks are hunted to near extinction almost instantly. Public pessimism is quickly corrected by these sophisticated market forces.
So, is Graham’s original formula dead? For most practical purposes, yes. You would be hard-pressed to find qualifying companies today. But its soul lives on. The core lesson—buying assets for less than their intrinsic worth—remains the bedrock of all sensible investing. It taught us to be disciplined and to seek a margin of safety.
The Power of Going Against the Grain: David Dreman’s Contrarian Approach
What if the real “magic” lies not in complex asset calculations, but in understanding human psychology? This is where David Dreman’s contrarian investing philosophy shines. Rooted in behavioral finance, Dreman argued that investors consistently overreact to both good and bad news. This creates pricing errors.
His formula was elegantly simple: focus on stocks with a low price-to-earnings (P/E) ratio. By building a diversified portfolio of these unpopular, out-of-favor companies, you could capture significant gains as the market corrected its initial overreaction. The data backs this up. For decades, baskets of low P/E stocks have consistently outperformed both the broader market and their high-flying, high P/E counterparts.
Why does this work? Analysts often suffer from “checklist syndrome,” overemphasizing projected growth and underestimating a company’s current, tangible earnings power. A low P/E ratio acts as an anchor to reality. Of course, the approach isn’t flawless. It can sometimes include “value traps”—companies that are cheap for a very good reason, like a dying business model. This is a key limitation to remember.
Demystifying Magic Formula Investing: Joel Greenblatt’s Winning System
Now, let’s get to the main event. In 2005, hedge fund manager Joel Greenblatt published “The Little Book That Beats the Market.” In it, he unveiled a straightforward, two-step screen that he dubbed the “Magic Formula.” Its brilliance lies in combining two powerful concepts: cheapness and quality.
The formula ranks stocks based on two metrics:
- Earnings Yield: This is essentially the inverse of the P/E ratio. It measures a company’s pre-tax operating profit relative to its enterprise value. A high earnings yield means you are getting a lot of profit for each dollar you invest. It’s a marker of being undervalued.
- Return on Capital (ROC): This measures how efficiently a company uses its money to generate profits. A high return on capital indicates a well-run business with a durable competitive advantage—a “good company.”
By combining these, the magic formula investing strategy aims to buy above-average companies at below-average prices. You simply rank all stocks, combine the two ranks, and buy the top 20-30 names. It’s a systematic, unemotional process.
Magic Formula Investing Results: Does It Still Work in 2025?
Theoretical backtests are one thing, but what about real-world magic formula investing results? Historical data is compelling. Greenblatt’s backtesting showed that his formula nearly doubled the market’s returns from 1988 to 2004. But what about today?
In the last decade, the strategy has experienced periods of underperformance, particularly during the tech-driven bull markets where growth stocks dominated. However, in more volatile or value-driven periods, it has often roared back. The key takeaway in 2025 is that the magic formula investing strategy is not a short-term trick. It’s a long-term discipline. Investors who stuck with it through its inevitable rough patches have generally been rewarded with above-market magic formula investing returns.
For those who don’t want to pick individual stocks, there are even magic formula investing ETF options available that attempt to replicate the strategy, though their fidelity to the original screen should always be verified.
A Peek Behind the Curtain: My Personal Experience with Formulaic Screens
Let me be candid. In my own investing journey, I’ve spent countless hours running screens based on these formulas. The magic formula investing screener on various financial websites is a fantastic starting point. However, here is the crucial reality check: a screen is a starting point, not the finish line.
Out of 100 highly-ranked companies, I might place a buy order on only one or two. Why? Because the formula can’t see everything. It can’t tell you if a company’s CEO is under investigation, if a new competitor is about to disrupt its core business, or if its accounting is aggressive. This deep dive—reading annual reports, analyzing industry trends—is the hard work that separates good investors from great ones. The formula gives you a focused list of candidates; your research confirms their viability.
The Investor’s Greatest Battle: Conquering Your Own Psychology
This is perhaps the most critical component. A magic formula investing approach is simple, but it is not easy. The difficulty is 100% psychological. You will be buying companies that are often out of favor. Their headlines will be negative. Meanwhile, your friends will be bragging about their soaring tech stocks.
Sticking to the strategy during these times requires immense discipline. You are fighting behavioral finance biases like herd mentality and recency bias. The formula forces you to be a contrarian, to be greedy when others are fearful. This emotional fortitude is the real secret sauce. Without it, even the best formula will fail.
Your Magic Formula Investing Blueprint: A 5-Step Action Plan
Ready to put this into practice? Here is your action plan for implementing a modern magic formula investing approach.
- Generate Your List: Use a free online stock screener. Set the filters for a minimum market cap (e.g., $100 million to avoid micro-caps) and then rank by both high earnings yield and high return on capital. Combine the ranks to get your top 20-30 stocks.
- Conduct Due Diligence: This is where you add value. Research each company. What is their business model? Who are their competitors? Is their debt level manageable? Look for red flags that the numerical screen missed.
- Build a Diversified Portfolio: Purchase an equal amount of 20-30 stocks from your final list. This diversification is crucial. It protects you from company-specific failures and ensures you capture the strategy’s systematic edge.
- Maintain Discipline and Rebalance: Hold each stock for exactly one year to qualify for favorable long-term capital gains tax rates (rules may vary by country). Then, sell and replace them with the new batch from your annual screen. Repeat this process year after year.
Conclusion: Your Path to Market-Beating Returns Starts Now
So, is there a magic formula for investing? The answer is a resounding “yes, but.” Yes, proven, systematic strategies like Joel Greenblatt’s exist and have a long history of success. But they require patience, emotional control, and a long-term perspective. They are not get-rich-quick schemes.
The most empowering part? You can do this. You don’t need a finance degree or a team of Wall Street analysts. You need discipline and a willingness to follow a process. The magic formula investing approach demystifies the stock market. It gives you a structured framework to make rational, unemotional decisions.
Start today. Run your first screen. Begin your research. Take control of your financial future. The potential for building lasting wealth is not a secret kept by the elite—it’s a method, available to anyone with the courage to follow it. You absolutely can outperform the market. Your journey begins with a single, formula-driven step.
