Last week I had a chance to read one of the most popular books on investing – “The Little Book that beats the market” by Joel Greenblatt.
Greenblatt explains how investors can systematically apply a formula that seeks out good businesses when they are available at bargain prices.
He goes into great details to make a lay investor understand as to why investing is important and how it is not a rocket science. That means with some effort a lay, small investor too can identify a list of stocks that s/he can use to build a portfolio and invest money for future wealth.
He further details the “magic formula” – a step by step process to identify these stocks. Just using two ratios – Earnings Yield and Return on Capital – you could have a shortlist of formidable stocks that are worth your money. All you have to do is rank them as per the formula and invest in the top 30. Reshuffle them every year based on the new rankings and voila, you are on your way to the riches.
He also shows how if someone had invested using this formula, they would have beaten not just the “fund managers” but also the ‘benchmark index’ hands down.
Boy, I was so tempted to drop everything (including reading the book) and implement this portfolio right away. But, the lazy being I am, I decided to go through with what else the author had to say.
And then came all the bummers.
- The magic formula’s magic will happen only if you are willing to stay put for 5, 10, 15 even 20 years. That’s when you really see the strategy win with flying colours. There is no instant gratification.
- There will be periods in between when the magic formula’s magic feels like fading. You may just wonder, if it was the right decision to use it in the first place.
- You will need a lot of faith to go on with the strategy. Now, think of it as your own personal index or benchmark and if you can keep repeating the formula year after year for decades, no one can stop you from getting rich.
- Ideally, use this strategy to invest for your kids and grandkids. Yeah, that’s right!
Just when I had started to believe that riches are coming my way!
Long Story Short of Magic Formula
Greenblatt says so and I tend to agree that any strategy needs time to work. There is hardly a strategy which will not, at least once, appear worse than others and make you question. Sometimes, long enough to make you lose faith.
The point is markets go up and down and so do stocks or mutual funds. If you have understood the strategy, you should give it a long enough time to prove itself.
“राह पकड़ तू एक चलाचल, पा जायेगा मधुशाला “
(Choose and walk one path and you shall find your destiny / destination. )– excerpt from “Madhushala” by Shri Harivanshrai Bachchan
The question is are you willing to commit long enough.
Even when something like a “Magic Formula” is readily available, there are very few people actually practising it. I am sure several gave up along the way.
In any case, do read up “The Little Book that Beats the Market“. There is a website too based on the Magic Formula – magicformulainvesting.com.
If you plan to work on the formula on India Stocks, you can use a site such as screener.in.
Trivia: I did not implement the formula but watched a movie mentioned in the book. “The Karate Kid” (1984 one) with 2 sequels. Mr. Miyagi – what a man.
Between you and me: What’s your magic formula of investing?
The LightHouse Newsletter shares a shortlist of stocks based on the Magic Formula. Want to know about our magic formula that you can use too? Click here.